If you have bad credit or don’t have enough credit built up, you may benefit from a credit builder loan. These loans aren’t your typical loan where you borrow money and repay it monthly. Instead, it’s a loan specifically meant to help you build up your credit score so that you can get a traditional loan in the future.
You don’t get a lump sum of money at the onset of the loan. Instead, you receive the funds once you pay off the loan.
Understanding Credit Builder Loans
A credit builder loan is just a way for you to prove that you can make your payments on time and therefore build credit. The amount you ‘borrow’ sits in a bank account with the lender that provides the credit builder loan. You make monthly payments like you would on a standard loan and the payments are reported to the three credit bureaus. You benefit by making on-time payments as that makes up 35% of your credit score.
Finding the Right Credit Builder Loan
Credit builder loans are available at a wide number of financial institutions; they just don’t normally advertise them. Some banks also call them ‘Fresh Start Loans.’ When you look around for the right loan, find one that has a short term, typically 24 months or less and a payment you can afford.
You don’t impress the credit bureaus by taking a larger loan with a larger payment. The idea is to show that you can make payments on time, of any amount. The payment history that makes up your credit score is just based on the fact that you pay your bills on time.
How it Works
You apply for the credit builder loan. Once approved, the lender keeps the money from the loan in a savings account. You make your payments like you would any other loan (hopefully on time). The lender sends your payment history to the credit bureaus and your credit score should increase. Once you pay off the loan, you receive the amount back from the lender and you walk away with a higher credit score.
Pros and Cons of the Credit Builder Loan
- Credit builder loans are like a forced savings account
- Qualifying is usually easy since the bank holds onto the funds
- You’ll build your credit score
- You’ll adopt good payment habits
- You may pay a fee to get the loan
- If you miss payments, you hurt your credit score which defeats the purpose of the loan
The credit builder loan, as the name suggests, helps you build credit when used correctly. Be careful not to overextend yourself making it hard to afford the payments. Choose the loan that fits easily within your budget and won’t require sacrifice. The idea is to give the credit bureaus reasons to give you a good credit score, not hurt your already low score. Shop around to find the lender with the best terms when choosing this option to ensure a positive outcome.