Many of your financial decisions are impacted by your credit, so when you have bad credit or no credit, simple tasks like taking out a loan, renting an apartment, or even getting a job are much more difficult.
Without any visible credit or repayment history, lenders will most likely determine that lending to you will be risky.
There are a few methods in which you can build and improve your credit, but in this article, we are going to specifically focus on credit builder loans.
Credit-Builder Loans: What They Do
A credit-builder loan is a specific loan in which the amount you borrow is held in a secured account while you pay off the loan in a timely manner and once it's completely paid off, the funds are released to you.
A credit builder loan is a tool that helps consumers with little, no, or bad credit to build their credit. By generating a history of positive payments, you can build a good score, which makes it easier for borrowers to take out credit cards and loans with lower interest rates.
How It Works
A credit-builder loan is similar to a regular loan since your receive funds that you will eventually pay off. The difference is that taking out a credit-builder loan and paying it off successfully shows lenders that you are serious about your credit.
Credit-builder loans are an excellent way to get started on building credit since there is no credit check (which will have minimal or no impact your credit) to take out a loan in which you can decide on the amount and terms that you can afford.
Once approved for the loan, the money you borrow is deposited into a secured savings account that you can only access when you have fully paid off the loan.
When you initially take out a loan, you will make a small down payment that is usually equal to your monthly payment. Your lender will keep your funds securely stowed away until the loan is fully paid off.
During this time, you make on-time monthly payments to your lender, which is reported by the three major credit bureaus.
Once the loan is fully paid off, you receive your full loan amount (without any fees and interest that were charged).
Just remember -- make your payments on-time and you will receive improved credit plus the loan amount.
Credit-Builder Loans And Your Credit
How do you know when it's time to take out a credit-builder loan? Generally, individuals that are just beginning their credit journey or struggling with poor credit are ideal candidates for a credit-builder loan.
Your credit score -- specifically your FICO® score -- is made up of five factors:
- Payment history: 35%
- Credit utilization: 30%
- Credit age: 15%
- New credit: 10%
- Types of credit: 10%
As you can see, the main factor that determines your credit score is your payment history, so a history of on-time payments will positively impact your credit. As long as you are making on-time payments with your credit-builder loan, your credit will benefit.
Additionally, a credit-builder loan will add an installment loan to your credit mix; generally, individuals with bad or no credit don't qualify for installment loans, so acquiring one and paying it off will be weighted more heavily than credit cards and other types of revolving loans.
Before you take out a credit builder loan, make sure the financial institution reports to all three bureaus rather than just one or two.
Just a note: don't confuse credit-builder loans with fresh start loans, starting over loans, or pledge loans: these either come with high interest rates or require some form of collateral.
The amount you pay for a credit-builder loan depends on the lender, although it generally ranges from $500 to $3,000. Aside from your initial down payment, you will also have to pay an APR (Annual Percentage Rate) or some other form of interest on the borrowed amount. Remember, the larger the loan, the more you will pay in interest.
Additionally, you may also be subject to fees such as a startup fee, origination fee, application fee, processing fee, and/or late payment fee.
Credit-Builder Loan Pros
- There is no credit check required to take out a credit-builder loan.
- When used responsibly, it improves your payment history and builds credit.
- Most consumers qualify for a credit-builder loan.
- A credit-builder loan adds to your credit mix.
- You learn good payment and saving habits.
- The funds are released to you once you successfully pay off the loan.
Credit-Builder Loan Cons
- Late and missed payments are reported to the credit bureaus, which can backfire on your purpose of building a positive credit history.
- These loans are not free and come with interest and fees.
Where To Get A Credit-Builder Loan
Interested in a credit-builder loan? There are many options to find the best one for you:
- Local banks and credit unions: If you are a member of a local bank or credit union, then this is a good place to begin your search. You can visit a local branch in person or submit an application online. Qualifying usually isn't difficult since you won't need any credit history -- just sufficient income to cover your payments and (depending on the lender) some form of collateral.
- CDFIs: There are around 1,000 Community Development Financial Institutions based in lower-income communities to specifically assist consumers who are struggling with their finances.
- Nonprofit organizations: Nonprofit organizations in your community may have resources to help you build your credit.
- Online lenders: With the popularity of online banks and lending, you can easily find a credit-builder loan online. One of the top lenders for credit-builder loans is Austin, Texas-based company Self Lender. Self Lender partners with FDIC-insured financial institutions such as Lead Bank and Sunrise Banks to offer these loans nationwide, without requiring upfront cash from consumers.
What Else You Can Do To Improve Your Credit
Even after you have taken out a credit-builder loan, you can continue to improve your credit by doing the following:
- Secured credit cards: These are similar to a credit-builder loan in the sense that they help build your credit, except you must have enough saved up to pay a security deposit. Secured credit cards may have annual fees and interest rates that are higher than those offered by a credit-builder loan -- up to 25%. Most banks allow you to upgrade to a traditional credit card once you have shown you are responsible for making timely payments.
- Become an authorized user: Credit card issuers may allow the primary cardholder to add an authorized user to the account, which helps the new user improve their credit by having an older credit card account added to their history. As always, make sure you make on-time payments.
- Credit repair: If you have already established credit history and you are simply looking to improve it, you may want to consider credit repair, which can dispute and remove incorrect or unverifiable items on your credit report. While you can improve your credit on your own, you can save time and get the best results by hiring a reputable credit repair company.
- Credit monitoring. You can use a credit monitoring site to monitor your credit in the future and protect your financial information.
The Bottom Line
Credit-builder loans can assist you in getting a start on building a positive credit history, but it is essential that you make on-time payments to get the best results.
Want to learn more about how to improve your finances? You can find more information here.
How does a credit-builder loan work?
Credit-builder loans a specific loans offered by banks and credit unions to help borrowers with little, no, or bad credit to build and improve their credit history. Your lender will report your payments to the three major credit bureaus: Experian, Equifax, and TransUnion, which establishes and builds your credit history.
How can I get a credit-builder loan?
There are many places where you can shop around to find the right credit builder loan for you:
- Local banks and credit unions
- CDFIs (Community Development Financial Institutions)
- Nonprofit organizations
- Online lenders (such as Self Lender)
How do I build credit when I have none?
There are several ways to go about this. First, practice good financial habits such as lowering your amount of debt and paying off past-due accounts. You can also take out a secured credit card, store card, secured loan, or credit-builder loan to begin establishing your credit history.
What does it mean to have insufficient credit references?
Being denied credit due to "insufficient number of credit references" means that you don't have enough accounts on your credit reports to meet your lender's requirement for extending credit.
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