One of the most effective ways to build credit is by using secured loans. The loans are secured because you pledge some type of collateral — like money in a savings account — to the lender in exchange for using their credit card. If you should fail to pay the money back, the lender knows that they can take your collateral.

Secured loans will get your foot in the door so you can start using credit. Lenders give you a chance, and you can build on your successes.

The bank knows that you are good for the money because they're holding it in your account. They'll freeze your account so that you can't take the money out, but this is a small price to pay for the chance to get good information in your credit report.

Secured loans are not a bad thing. In fact, the holy grail of all loans — the home mortgage — is a secured loan. In exchange for your home-purchase funds, your lender has the right to take back, or foreclose on, your house if you fail to pay as agreed.

Secured Credit Cards

One of the most powerful credit-building moves you can make is to use a secured credit card. A secured credit card offers the ability to use a standard credit card at little risk to the lender. To do this, you make a deposit into your bank or credit union account. Then, you apply for a secured credit card with the same dollar limit as your deposit. You must apply for the card from the same institution that has your deposit. For example, if you deposit $500 into a savings account, you might apply for a credit card with a $500 limit.

Your secured card acts just like an unsecured credit card. You can use it in all the same places, and nobody except you and the bank will know that it's a secured card. Keep in mind that the bank is taking some risk, so they'll likely pull your credit just to make sure you won't get out of hand. Even though the card has a limit, it is possible to charge more than the limit, and doing this will get you in trouble.

Expanding the Foundation

Once you have a secured credit card, it is essential that you use it responsibly. Use it in moderation, and pay down the balance every month. Use the card even if you have the cash to pay for what you are buying — the key is to show others that you can use credit. If you do this, lenders will eventually see you as an attractive borrower.

As time goes on, you should be able to increase your access to credit. Perhaps you can have the bank raise your limit above the amount that you keep on deposit. This will improve your credit score by decreasing your credit utilization, and it will be a stepping stone to even greater loans. Ask about a credit-line increase every six to eighteen months until you have received several increases.

The best time to ask for an increase is when you are only using a small portion of your available balance. Otherwise, your lender might think you've fallen on hard times and you are becoming a default risk. Of course, you should not use your full credit line when you are building credit — you're just showing them that you can handle the responsibility.

Secured Auto Loans

In addition to credit cards, you can use an auto loan to help build your credit. The concept is similar to the concept of a secured credit card. However, your deposit might not be large enough to pay the whole cost of your automobile. That's okay, because the loan is secured by your deposit plus the auto itself, the bank should be able to get its money back if it repossesses the car.

The auto loan shows up as an installment loan on your credit report, so you can add some variety and spice to the items in your history. In some cases, your financial institution might not pull your credit history if you use a secured auto loan — this is more likely at smaller institutions and credit unions. This means you can reduce hard inquiries, as well as get a loan no matter how bad your history is.