An excellent credit score is an essential vital for your financial mobility.
Are you struggling to build or rebuild your credit score? Are you wondering if there are solutions out there that can work for you?
Here’s some great news. There are various ways to build or re-build your credit right from scratch.
You can ask a close friend, relative, spouse or parent to add you as an authorized user on their credit card; or ask them to take out a loan with you as a co-signer. Alternatively, you can go for a secured credit card and start building or rebuilding your credit.
However, a less well-known way to solve your credit woes is the credit builder loan.
Credit builder loans are smaller, secured and not as widely touted loans. They are mainly offered by smaller lenders such as credit unions and online lenders and are commonly referred to as savings secured loans, or fresh start loans.
So, if you are looking for a “fresh start” on your credit score, read on and find out how you can use it to solve your credit score woes.
The Purpose of Credit-Builder Loans
The main goal of credit builder loans is to create an easy way for consumers to improve or establish a good credit history and thereby set them up for a great credit score.
From the lender’s perspective, it’s a relationship building loan. The loans don’t offer significant “immediate” profit since they are often of low value over long periods. However, they are excellent for establishing links for lasting client loyalty.
For the client, credit builder loans are designed to help you get accustomed to making regular payments and successfully repay a loan. Since there’s no risk to the lender, and the borrower does not need the money, the sole purpose of the loan is to build or improve one’s credit score.
But how do they work?
How Credit-Builder Loans Work
Credit builder loans have several fancy names. However, there are three major ways that lenders structure the loans: Pure Credit Builder Loans; Secured Credit Builder Loans and Unsecured Credit Builder Loans.
Pure Credit Builder Loans
Pure Credit Builder Loans are the traditional credit builder loans where the lender advances the borrower some cash, but borrowers cannot touch it. Instead, the cash is “locked” in a savings account which remains inaccessible until when you have “successfully completed your repayments.”
It works like a deferred savings plan, and you’ll get to grow a small nest egg and reap some interest at the end of the term.
Secured Credit Builder Loans
The term “secure” implies that the loan is guaranteed by a savings account or a deposit account. Since you already have the money and all you need is for the lender to advance the loan against what you already have in savings. Lenders demand fewer requirements and it attracts a lower interest rate.
Unsecured Credit Builder Loan
The last category is typically sought after by borrowers who need the cash upfront for a personal expense. The plan works like a credit card agreement. Once, you’ve gone through the process and have the money available, you are expected to make payments, including interest payment, within a specified time.
If you make all your payments at the agreed time and cover the entire amount, the lender refunds you the entire amount, including the interest. This is a great option for borrowers who are in need of the cash and need to build the credit score.
However, the caveat is the lender’s exposure which in turn triggers higher interest rates and more stringent scrutiny of borrowers.
Generally, Credit builder loans have fewer requirements than conventional loans. However, the specifics vary with the institutions. The most important requirement for a borrower is proof of income that would allow comfortable monthly payments of between $ 50 and $ 150 during the loan term.
For first time borrowers, credit builder loans act as the training wheels on a bicycle. They have few requirements, are easy to get, repay and offer excellent experience in loan repayment. Borrowers also benefit from improved credit scores. Unless you have a serious problem with handling money, it should work perfectly well with anyone.
How a Credit -Builder Loan Affects Your Credit
It is commonly said that Rome wasn’t built in a day. But John Heywood made an important observation, “they were laying bricks every hour.” The same applies to your credit score. A credit builder loan provides “bricks” to build an excellent credit score. But, ultimately it depends on how you manage the loan.
Every full and on-time payment is reported to the credit reference bureaus and although it may take some time for the impact to reflect on your credit score, credit builder loans can help you leap 20 to 25 points on your credit score. A modest leap, nonetheless, a positive step that will certainly help.
Who Benefits from Credit-Builder Loans?
Unlike traditional loans which require you to be in great financial shape and have excellent credit ratings, lenders in this sphere don’t look for financial fitness, instead, they look for stability and the prospects of future lending.
For instance, if you have held a checking account without overdrafts, or if you’ve met your rent obligations for some time without hitches.
Credit builder loans are perfect for people looking to build a decent credit history such as:
1. Recent college graduates who don’t have credit cards and are yet to build a credit history. Such a loan will give you a positive rating on your credit score and in turn, change the way lenders, landlords and certain employers look at you.
2. If you are seeking to re-establish your credit scores. Since lenders are not looking for perfection. Your stability is what counts and as you start clawing back those vital points on your score, lenders will change how they perceive you.
3. People looking for a fresh start such as recently divorced or recently arrived immigrants.
4. And people seeking to improve their credit scores in order to achieve certain milestones such as a home loan or an auto loan.
You can use the credit builder loan to enhance your credit score and earn a lower interest long-term loan such as a mortgage or auto-loan in just a few years.
You can use the Lending Tree App to check your credit score as you progress.
Making a credit-builder loan work for you
Ensure that it Works for You
Before signing on the dotted line on a credit-builder loan agreement, you need to make sure it works for you. First, you need to be sure that the lender will report the facility to the three major credit bureaus. If not, the impact of the report, thus intended effect of taking the loan is significantly reduced.
Gauge Your Readiness
This is especially so for borrowers who are recovering from financial downfalls such as bankruptcy. If previously you’ve had trouble meeting your financial obligations, you should assess and probably get counsel on your readiness to borrow.
You don’t want to make bad matters worse as a failed or delayed payment would be reported to the credit bureaus as such thus compromising your score.
Understand the Terms.
After you are sure of your readiness, you need to be clear of the terms of the loan. You need to know how it works, the interest rate, collateral needed (if needed), monthly installments and whether the payments are reported to the three major credit reference bureaus.
If you are not clear on something, ask until you get it right.
Choose the “Best Fit Loan”
Armed with a good knowledge of your readiness and the product features, choose the loan that “best fits” your situation and gives you the best value.
Are you a fresh graduate looking to establish your credit history? Or are you looking re-build your credit after a financial pit? Are you a recent divorcee or immigrant looking for a fresh start?
Some lenders have specific credit builder loan products, tailored for specific target groups of people such as people with disabilities or recent divorcees. Ensure you scrutinize and pick what is best suited for you.
Make on-time Payments Always
Like any other loan, it is vital that you make on-time payments. All information, whether positive or negative is reported to the credit bureaus. Therefore it is crucial that you set up automated payments from your account and ensure that your account always has sufficient balances to avoid overdraft charges.
Don’t be in a Hurry
Credit builder loans are often small amounts, between $ 500 and $ 2,000, with loan terms spanning 12 to 24 months. Many people get impatient and opt to pay the loan off sooner. However, this contradicts the whole purpose, to build the credit score which takes time.
Instead, you should take the entire loan term to pay it off. The longer you have it running, and well-serviced, the more reports are made to the bureaus. Furthermore, credit bureaus such as FICO require that the account should be opened and reported to the bureau for at least six months before they give a valid score.
Ensure that all Your Accounts are in Order
Credit scoring is never an outcome of a single account. Instead, it is a result of the combined outcomes of multiple credit accounts. Therefore, you ought to ensure that all your accounts, including the non-credit builder accounts, are well-serviced and get the attention they deserve.
Remember, a slip up on a single payment will cause your credit score to tumble.
Where to find credit builder loans
Because of their size and nature of target customers, credit builder loans are not popular amongst the traditional banks or as well-marketed as conventional loans. They are regarded as “low profit” products thus are more popular with unconventional lenders including:
Credit unions. Interest rates are generally lower than with other unsecured loans, and many credit unions place your loan in a savings account, where it earns a little extra interest.
Online lenders such as self lender will help you rebuild your credit without having to leave your location. Online lenders work in collaboration with banks to issue a certificate of deposit and keep it valid until the entire loan is paid off, and all payments are reported to the major credit bureaus.
Nonprofit organizations that focus on economic empowerment of specific segments of the populations which they serve. For instance, recent divorcees, refugees or people with disabilities may receive credit builder loans as a way of financial empowerment.
You can find a list of institutions that offer credit builder loans in your state at Consumer-union.org. Although this may not be a comprehensive list, it’s a great place to start.
Alternatives for Building Credit
Credit builder loans are an excellent way to build or rebuild your credit score. However, they are not the only option. If you are looking at rebuilding your credit rating, consider engaging a credit repair company. Firms like Lexington law offer a tiered and affordable way to scrutinize your credit report and do the back-breaking task of fixing it.
You can seek other alternatives to build, or rebuild your credit including the following:
Secured credit cards: These are credit card products where the card issuer requires you to make a deposit before issuing you with the card.
The card issuer also caps your credit limit at the value of the deposit amount or slightly lower, to cater for interest payments, but reports all payments to the major credit reference bureaus.
Like the credit builder loans, you don’t have to pay interests, however, secured credit cards attract higher interest rates.
Authorized credit card users: You can be added to an existing credit card account as an authorized user. The primary cardholder still maintains full liability for the debt, and on the other hand, the authorized user benefits from the existing credit history.
For instance, a recent college graduate can be added as an authorized user of their parent’s credit card. When properly managed, this arrangement works perfectly fine for the new user.
However, it can work against you if the primary credit card holder fails in their obligation
Co-signing on a loan is closely related to authorizing users. Here, you co-sign a loan for a partner who has an excellent credit rating in order to obtain a loan.
As long as the borrower makes on-time payments, you benefit from enhanced credit score. However, you also share liability, thus if the co-signee fails to make payments, it will blowback to your credit scores as a failed obligation.
Credit builder loans are an excellent choice for building your credit history and it has its fair share of pros and cons. The loan amounts are small making the repayments manageable. But it’s not a guarantee for improving your credit score. You must take the loan seriously, commit to on-time payments, not be in a hurry to finish the loan and watch your other accounts in order to make it work for you.