When it comes to building credit, most people think of traditional methods like paying bills on time, keeping credit utilization low, and monitoring credit reports. However, there’s another way to potentially build credit that’s often overlooked: investing. But does investing really help you build credit, or is it just a myth?
Understanding Credit Scores
Before we dive into the relationship between investing and credit, it’s essential to understand how credit scores work. Credit scores are three-digit numbers that represent an individual’s creditworthiness, ranging from 300 to 850. The major credit reporting agencies, Equifax, Experian, and TransUnion, use complex algorithms to calculate credit scores based on information in credit reports.
The most widely used credit score model is the FICO score, which considers the following factors:
- Payment history (35%): On-time payments, late payments, and accounts sent to collections
- Credit utilization (30%): Amount of credit used compared to available credit
- Credit age (15%): Length of credit history and age of oldest account
- Credit mix (10%): Variety of credit types, such as credit cards, loans, and mortgages
- New credit (10%): Recent credit inquiries and new account openings
The Connection Between Investing and Credit
So, how does investing fit into the credit score equation? The answer lies in the type of investment and how it’s reported to the credit bureaus.
Investment Accounts and Credit Reports
Certain investment accounts, such as margin accounts or investment loans, can be reported to the credit bureaus. This is because these accounts often involve borrowing money to invest, which is a form of credit. When you borrow money to invest, you’re essentially taking out a loan, and the lender may report your payment history to the credit bureaus.
For example, let’s say you open a margin account with a brokerage firm to invest in stocks. You borrow $10,000 to invest in a particular stock, and you agree to repay the loan with interest. If you make timely payments on the loan, the brokerage firm may report your payment history to the credit bureaus, which can help build your credit score.
Diversifying Your Credit Mix
Investments can also help diversify your credit mix, which is an essential factor in determining your credit score. By adding different types of credit, such as investment loans or lines of credit, you can demonstrate to lenders that you can manage various credit types responsibly.
For instance, let’s say you have a credit card, a personal loan, and a mortgage. Adding an investment loan or line of credit to the mix can show lenders that you’re capable of managing multiple credit types, which can lead to a higher credit score.
Investments That Can Help Build Credit
While not all investments can help build credit, certain types of investments can have a positive impact on your credit score.
Investment Loans
Investment loans, such as margin loans or securities-backed lines of credit, can help build credit when used responsibly. These loans allow you to borrow money to invest in stocks, bonds, or other securities, and the lender reports your payment history to the credit bureaus.
To build credit with investment loans, make sure to:
- Make timely payments: Late payments can negatively affect your credit score, so make sure to pay your loan installments on time.
- Keep credit utilization low: Avoid borrowing too much money, as high credit utilization can harm your credit score.
Robo-Investing Platforms
Some robo-investing platforms, such as Robinhood or Wealthfront, offer lines of credit or loans that can help build credit. These platforms often report payment history to the credit bureaus, which can contribute to a higher credit score.
When using robo-investing platforms to build credit, consider the following:
- Choose a platform that reports to credit bureaus: Not all robo-investing platforms report payment history, so make sure to choose one that does.
- Use credit responsibly: Only borrow what you need, and make timely payments to avoid negative marks on your credit report.
Investments That Won’t Help Build Credit
While some investments can help build credit, others won’t have any impact on your credit score.
Stocks and Bonds
Buying and selling stocks and bonds is a type of investment that won’t affect your credit score. These investments don’t involve borrowing money, so there’s no payment history to report to the credit bureaus.
Real Estate Investing
Investing in real estate, such as rental properties or real estate investment trusts (REITs), typically won’t impact your credit score. While you may need to take out a mortgage to finance a real estate investment, the payment history is usually reported under the property’s address, not your personal credit report.
Conclusion
Investing can be a valuable tool for building credit, but it’s essential to understand the types of investments that can help and how to use them responsibly. By diversifying your credit mix, making timely payments, and keeping credit utilization low, you can potentially improve your credit score. However, not all investments will have a positive impact on your credit, so it’s crucial to choose investments that align with your financial goals and credit-building strategies.
Remember, investing should never be used as a sole means of building credit. A well-rounded approach to credit-building involves a combination of responsible credit behavior, timely payments, and a diverse credit mix. By incorporating investing into your overall credit-building strategy, you can potentially see improvements in your credit score over time.
In the end, building credit requires a long-term commitment to responsible financial behavior and a deep understanding of how credit scores work. By educating yourself on the relationship between investing and credit, you can make informed decisions that can help you achieve your financial goals.
How does investing affect my credit score?
Investing itself does not directly impact your credit score. However, the way you invest and manage your investments can have an indirect impact on your credit score. For instance, if you take out a loan to invest in a business or property and make timely payments, it can help improve your credit score.
It’s also worth noting that some investments, such as peer-to-peer lending, may require a credit check, which can result in a hard inquiry on your credit report. This can temporarily lower your credit score. However, if you’re making wise investment decisions and managing your debt responsibly, the long-term benefits can outweigh the short-term effects on your credit score.
Can I use an investment property to build credit?
Yes, investing in a rental property can help you build credit. When you take out a mortgage to purchase an investment property, making timely payments on the loan can help establish or improve your credit history. Additionally, if you’re able to refinance the property or take out a home equity loan, making payments on those loans can also help build credit.
It’s essential to keep in mind that building credit with an investment property requires responsible management of the property and the associated loans. Missed payments or defaulting on the loan can have a negative impact on your credit score. However, if you’re able to manage the property and loans effectively, it can be a great way to build credit while generating passive income.
Can I use a brokerage account to build credit?
While a brokerage account itself won’t help you build credit, you can use the account to make investments that can indirectly help. For example, you can use the account to invest in dividend-paying stocks or peer-to-peer lending platforms that report payment history to the credit bureaus.
It’s essential to note that not all investments made through a brokerage account will help build credit. You’ll need to choose investments that involve loans or credit, and ensure that the lender or investment platform reports payment history to the credit bureaus. Additionally, you’ll need to make timely payments and manage the investments responsibly to see a positive impact on your credit score.
How do investment apps and platforms report to credit bureaus?
Some investment apps and platforms report payment history to the credit bureaus, while others do not. It’s essential to research the app or platform you’re using to determine if they report payment history. For example, some peer-to-peer lending platforms report borrower payment history to the credit bureaus, which can help build credit.
Even if an investment app or platform doesn’t report payment history, you can still use the platform to make smart investment decisions and build credit indirectly. For instance, you can use the platform to invest in a diversified portfolio, generate passive income, and then use that income to pay off debts or make timely payments on loans, which can help build credit.
Will investing in the stock market help me build credit?
Investing in the stock market itself will not directly help you build credit. Stock market investments do not involve loans or credit, so there’s no payment history to report to the credit bureaus. However, the returns on your investments can provide the capital needed to make smart financial decisions that can help build credit.
For example, you can use the returns on your investments to pay off high-interest debt, make timely payments on loans, or invest in other assets that can help build credit. By making smart financial decisions and managing your debt responsibly, you can indirectly use your stock market investments to build credit.
Can I build credit with a robo-advisor?
Robo-advisors are automated investment platforms that provide diversified investment portfolios with minimal human intervention. While robo-advisors can help you make smart investment decisions, they do not directly report payment history to the credit bureaus, so they won’t help you build credit in the classical sense.
However, the returns on your investments made through a robo-advisor can provide the capital needed to make smart financial decisions that can help build credit. For instance, you can use the returns to pay off debt, make timely payments on loans, or invest in other assets that can help build credit. By making responsible financial decisions, you can indirectly use a robo-advisor to build credit.
Is it worth investing to build credit?
Investing can be a great way to build credit, but it’s essential to approach it responsibly. You’ll need to choose investments that involve loans or credit and ensure that the lender or investment platform reports payment history to the credit bureaus. Additionally, you’ll need to make timely payments and manage the investments effectively to see a positive impact on your credit score.
If you’re able to make smart investment decisions and manage your debt responsibly, investing can be a great way to build credit while generating passive income. However, if you’re not careful, investing can also lead to debt and financial difficulties if not managed properly. It’s essential to approach investing with a solid understanding of personal finance and a long-term perspective.