Credit Builder Loan – How Does It Help Raise Your Credit Score?
If have a bad credit rating, your access to personal loans might be limited or come with extremely high interest rates. Instead of just accepting this fate, it’s always better to build up your credit score, and a credit builder loan can help.
It carries no risk for the creditor, as you’ll receive the funds after the final installment has been paid. Doing this boosts your history of timely payments, which is crucial for raising your credit score. Still, there are many tricky parts about using this type of loan properly so this guide will clear everything up!
- The credit builder loan helps boost credit scores as the creditor sets your monthly payments aside into a savings account
- Payments are reported to major credit bureaus, which reflect on your credit score and credit history
- The loans can last from 6 to 24 months and come in different sizes and terms
- Some credit builder loans can even earn you a small amount of interest
- Credit builder loans are different from secured cards since you can only access the funds after repayment
What’s A Credit Builder Loan?
A credit builder loan is one of the best ways to build your credit score as it affects your history of timely payments. However, it’s a lot different than traditional personal loans, since you won’t get any sum of cash upfront.
Instead, you apply for the credit builder loan when your finances allow making monthly payments to the creditor. The cash amount equal to the total sum of those monthly payments will be paid by the creditor into a savings account in your name.
Once you successfully pay off the loan, you’ll be able to access the funds in the savings account. Of course, you’ll have to pay some interest, but you won’t lose much money in the process which allows a significant raise in your credit score.
Think of it this way – using a credit builder loan to boost your credit rating will pay off in the long run, since your next interest rate on a personal loan will be lower. Payment history affects your FICO score by about 35%, so it’s no wonder that these loans can save you the trouble of paying high interest.
The good thing is – you can always qualify for a credit builder loan, even with bad credit! You only need to prove to the creditor that your monthly income suffices when it comes to repayment. Still, it’s all just the beginning of the process, since a lot depends on your plan and the APR on the loan.
Key Factors To Look For In Credit Builder Loans
There are different financial institutions that offer a credit builder loan, so naturally, there’s a variety of loans to choose from. However, here are a few crucial things to look for in a credit builder loan, so it will make the most sense both for your budget and credit score:
- The creditor should report to three major credit bureaus
- Length and size of the loan
- Cost of the loan
- Interest-earning savings accounts
These are all crucial aspects of getting the right credit builder loan for you, so you don’t end up overwhelmed by the payments due to picking the wrong lender. So, we’ll touch on all of those points to explain why these loan features should have your attention.
Reporting To All 3 Credit Bureaus
The first thing you should ensure is that the creditor reports to all three credit bureaus, otherwise the loan wouldn’t work as intended. It is, after all, a credit builder loan, and the only way you can build up your credit is if your payments are reported to credit bureaus each month.
Make sure that the lender reports to Equifax, Experian, and TransUnion, since some of them only report to one or two. This way, you’ll boost your credit score and the loan will reflect on all three of your credit reports, which comes in handy for future loan applications.
Picking A Credit Builder Loan That Suits You The Most
Credit builder loans should help credit newbies and consumers with bad credit improve their rating, but who said you can’t shop around for the best offer? You should carefully plan your budget before deciding on the best credit builder loan to take, and this includes the length and size.
You’ll usually find credit builder loans that range from 6 months to 24 months, so feel free to go with the latter if you are on a tight budget. The only downside to taking a 24-month loan is you’ll need to wait longer for the loan to impact your scores.
So, if you are in a rush to raise your credit score, going with a 6-month loan could be faster, but also more expensive. That’s where annual fees and interest rates come into the equation. You should look for the most convenient option for you, and the loan amount also plays a significant role.
Cost Of The Loan
You’ll mostly find credit builder loans ranging from $300 to $1000, and the loan amount could also affect the rates. The APR could range anywhere from 6% to 15%, so it’s an important factor to watch out for.
There’s also the chance that a one-time administration fee will be charged, but it’s usually no more than $10. With all these factors in mind, you can plan before the loan proceeds.
You Can Even Earn A Little Interest With The Loan
If you have a low credit score, financial products like credit builder loans can lead to positive payment history.
With all the interest you have to pay it could leave you wondering if the credit builder loan is even worth it? That’s a fair question and depends on how bad your credit score is, to begin with, but you also might be able to earn a little bit of interest back from your loan.
How is this possible, you might wonder? Well, some credit builder loans where your payments go to a savings account could bear interest. Of course, it’s not much and you’ll rarely find an option that earns more than 1.5% interest on the savings amount.
Still, it’s better than nothing, since you’ll surely pay higher interest rates for securing the loan in the first place. Why not return some of that interest through an interest-bearing credit builder loan then?
Institutions That Offer Credit Builder Loans
Now that you know how credit builder loans work, it’s time to get into the list of institutions that offer such services. Here are the main types of financial institutions that offer credit builder loans:
- Online lenders
- Community banks
- Credit unions
You can pick an institution that suits you the best, and online lenders may seem like the most convenient option. Still, make sure to check out the local banks as well, along with credit unions, since you might stumble upon better terms.
Besides annual fees and interest rates, some creditors won’t check your credit history. Also, you should only go with creditors that don’t conduct hard inquiries which will reflect negatively on your credit report.
So, make sure to consult your lender before taking the loan, and to understand all the conditions before securing it.
Tips For Using The Loan
Like with other financial services, there are some “tactics” you can apply to avoid any risks behind credit builder loans. If used correctly, these loans can renew your negative credit history through fixed monthly payments, and help you establish credit fast.
So, the number one tip is to never miss a loan repayment. Remember, you are doing all this to eventually unlock the funds, and boost your score, so on-time payments are crucial. If you miss even a single payment, it can all be in vain and your credit score won’t be boosted.
It’s a good thing that you can reach out to creditors that don’t conduct hard inquiries, and simply ask around. Once you get to know all the loan terms, you can calculate the monthly rate that wouldn’t hurt your budget too much so you don’t risk missing a payment.
You can pick a loan that earns interest on the funds in your savings account but calculate the difference between this interest and the interest paid on the loan. Sometimes, it just isn’t worth it.
Finally, you can request a report from the major credit bureaus to see if the credit builder loan already helps build credit while you are underway.
Difference Between Credit Builder Loans And Secured Cards
If you have a valid bank account, there are other options for building credit, and one of them is getting a secured credit card. However, the credit builder loan works differently when compared to a secured card, so it all depends on what suits you best.
Getting a secured credit card will mean you can use the credit limit on your card that you’ve previously deposited. This way, you can also build a history of on-time payments by making small payments every month to prove your creditworthiness.
Still, using a secured card is different from credit builder loans in a way because you can’t access the funds until you repay the balance in full.
For some borrowers, credit builder loans are much safer since you won’t be tempted to use the balance for other things.
Both options are great for building credit, but it’s better to go with a credit builder loan if you want to save the loan funds and access them in full after repayment.
Credit Builder Loan Fees
Along with the interest payments, there are other fees on credit builder loans. We already mentioned the APR loan term you can expect, and these mostly range from 6% to 16%. However, you should be aware that there might be a fee for being late on a repayment.
Administrative fees can also vary from one lender to another, so it’s best to reach out to your credit union or bank to inquire about the conditions. This way you’ll know the exact fees you can expect to pay, and there won’t be any surprises.
Out of all banking services, a credit builder loan makes one of the best options for building up your credit. It’s perfect for consumers with a bad credit score or those that wish to simply start their payment history the right way.
Make sure to shop around for the best offer, and to check if the lender submits payment information to credit reporting agencies.
It can sometimes be a better option than using a secured credit card or being an authorized user on someone else’s card since you can save a lump sum of cash in the end.
Frequently Asked Questions (FAQ):
What are credit builder loans?
Credit builder loans are different from the regular personal loan since you don’t get any lump sum of cash upfront.
Instead, you make the monthly payments to the creditor, and the creditor deposits the funds into a savings account in your name.
So, you can boost your history of payments and save up some cash in the end.
What are the benefits of a credit builder loan?
With a credit builder loan, the creditor will report your payments to credit bureaus, which can boost your credit score.
Another benefit is that it’s the easiest way of increasing your scores even if you have bad credit, and no hard inquiries apply to most lenders.
How much does a credit builder loan raise your credit score?
A credit builder loan can boost your credit score by about 60 points within the first few months of taking the loan.
More importantly, it manifests your ability to repay the debt on time for future lenders, which can result in lower interest rates.
How much can I borrow with a credit builder loan?
You don’t exactly borrow funds with a credit builder loan - you rather make payments to the creditor, which is the opposite of regular personal loans.
The creditor then uses the payment to fund your savings account, and you get the whole amount released upon paying the entire loan amount.
These loans typically range from $300 to $1000, while some creditors let you deposit up to $3000 to boost your score.
Rory AckermanHi, I'm Rory! I've worked in the banking industry for quite some time and wanted to help provide my expertise with all things credit related. In my spare time I like to play video games and collect sports cards.
DIY Credit Repair – Learn How You Can Improve Your Credit Score
Luckily, there are several things you can do on your own for successful credit repair and to improve your score. We made sure to bring you the complete DIY...