Does a Certificate of Deposit Build Credit?

Understanding Certificates of Deposit

A Certificate of Deposit (CD) is a type of savings account offered by financial institutions. When an individual purchases a CD, they deposit a specific sum of money for a predetermined period, known as the term, typically ranging from three months to five years. In exchange for keeping the funds deposited for the entire term, the financial institution pays interest at a fixed rate, generally higher than traditional savings accounts. This provides a predictable return on the investment. However, accessing the deposited funds before maturity usually incurs penalties, such as forfeiture of a portion of earned interest.

CDs are primarily savings vehicles, providing a secure way to save money. They are considered low-risk investments because the principal amount is typically insured by federal agencies up to certain limits, protecting against financial institution failure. The fundamental nature of a CD involves depositing money rather than borrowing it.

How Credit Scores are Determined

Credit scores are numerical representations of an individual’s creditworthiness, reflecting their history of managing debt. These scores are calculated using information from credit reports, which compile data from various lenders. The primary factors influencing a credit score include payment history, amounts owed, length of credit history, new credit applications, and types of credit accounts.

Payment history carries significant weight, illustrating an individual’s consistency in making timely payments. Late payments, defaults, or bankruptcies can negatively impact a score. Amounts owed, often called credit utilization, assess the proportion of available credit currently being used. Keeping credit utilization low, typically below 30% of the available credit limit, generally benefits a score.

The length of credit history considers how long an individual has had credit accounts open. A longer history of responsible credit management tends to have a positive influence. New credit inquiries and recently opened accounts can temporarily lower a score, as they might indicate an increased risk profile. The mix of credit types, such as installment loans (e.g., auto loans, mortgages) and revolving credit (e.g., credit cards), also factors into the overall score, demonstrating an ability to manage different forms of debt responsibly.

Why Certificates of Deposit Do Not Build Credit

Certificates of Deposit do not contribute to an individual’s credit score because they are savings products, not credit products. When you open a CD, you deposit your own money, essentially lending it to the bank for a set period. There is no borrowing involved, and consequently, no repayment obligation.

Credit bureaus, organizations compiling credit reports and calculating scores, primarily track borrowing and repayment behaviors. They record information such as loan amounts, credit limits, and payment due dates. Since a CD does not involve extending credit or establishing a repayment schedule, there is no relevant activity for these bureaus to report.

Therefore, financial activity associated with a CD, such as the initial deposit or interest accumulation, is not reported to credit reporting agencies. Without information to report, a CD account has no direct impact on an individual’s credit history or score.

Financial Products That Can Build Credit

Individuals seeking to establish or improve their credit can utilize several financial products that report payment activity to credit bureaus. Secured credit cards offer a viable option, particularly for those with limited credit history. These cards require a cash deposit, typically a few hundred to a couple of thousand dollars, which serves as collateral and often becomes the credit limit. The card functions like a traditional credit card, requiring regular payments for purchases, and this activity is reported to credit bureaus.

Credit-builder loans represent another effective tool for establishing credit history. With this loan, a financial institution lends a small amount, often between $300 and $1,000, held in a locked savings account or CD. The borrower makes regular payments over a period, such as 6 to 24 months, and these payments are reported to credit bureaus. Once the loan is fully repaid, the funds are released to the borrower, providing a responsible way to build credit while accumulating savings.

Traditional unsecured credit cards also play a significant role in credit building when managed responsibly. These cards do not require collateral and offer a revolving line of credit. Consistent on-time payments and maintaining low credit utilization, typically below 30% of the credit limit, are crucial for positively impacting a credit score. Installment loans, such as auto loans, student loans, or mortgages, contribute to a credit history through their fixed monthly payment schedules, with timely payments demonstrating reliable debt management.