Credit Builder Loan – Do Credit Building Loans Really Build Credit?
A credit builder loan is a unique type of loan where a bank or credit union holds the amount borrowed in an account while you make payments. This lets you build credit while the bank limits the risk that you won’t make your payments. You only get the money when the loan is paid off. Credit building loans are designed to help build up and improve the credit score for people who little or no credit history. There are solid reasons to build your credit in this way. A good credit score makes approval for credit cards and loans more likely, and at better rates. Credit-builder loans do not require good credit for approval. They do require that you have enough income to make payments. The bank is protected because the amount you borrow is held in an account while you make payments.
Credit Building Loans – How They Work
Credit Builder Loans – Why Banks will Make Loans to Risky Borrowers
Because lending involves risk, lenders are more inclined to lend money to people who have good credit. They usually offer better terms and rates as well. This is because good credit signals that someone has already demonstrated they are more likely to pay back a loan. But how do you build credit if a lender will not give you the chance to prove you are a good risk? Obviously, it is difficult to build good credit unless a lender gives you a chance to prove you are worthy. Of course, this makes sense from a lender’s perspective. They don’t want to risk losing money on an unknown borrower. From the borrower’s perspective, it’s frustrating if you’re trying to borrow and no lender wants to be the first to do business with you.
Credit building loans are a way lenders can provide you a loan without taking a risk that you won’t pay it back. With a credit builder loan, a lender doesn’t actually give you access to money you want to borrow. At least not until you’ve paid for the loan in full. In this way, they control the funds, and therefore don’t risk anything. As a result, lenders that offer credit builder loans are more willing to give them to borrowers with poor or no credit. Once you’ve got the loan, the lender reports on your payment history to credit-reporting agencies. This helps you build credit, because you’re creating a history of on-time loan payments.
Reasons to get a Credit Builder Loan
Credit builder loans come in especially handy if:
- Thin to no credit history – Getting credit is essential. Your credit history is reviewed regarding all aspects of basic existence including a living arrangements, transportation, background check for a job.
- You prefer not to use other credit Taking on additional credit can build your credit score. For example, multiple cards can build credit, but they can be a burden. They can also get out of hand with many horror stories of unmanageable credit card debt.
- Preparation for a financial milestone – Buying a first home is an obvious hurdle. So is buying a car. Better credit means more attractive interest rates. It’s just good planning to build your credit score first.
- Starting over – Maybe you’re young and new to the US credit system, or rebuilding after a crisis. In either case, building credit can be challenging. Credit building loans let you take control of your credit and improve it for the future.
How does a credit builder loan work to better your score?
A credit-builder loan can help build credit if you pay on time. Payments are reported to the three major credit bureaus, Equifax, Experian and TransUnion. Payment history is weighted more heavily than any other factor in calculating your credit score. Therefore, making on-time payments on a credit-builder loan can help you improve your credit profile.
Credit-builder loans are typically offered by smaller financial institutions. Local credit unions and community banks are likely lenders. When you get a credit-builder loan, the money you borrow is deposited into a bank account held by the lender. You then make monthly principal and interest payments, for a term usually around six to 24 months. Your payment progress and history are reported to the three major credit bureaus. When the loan is paid off, you get to keep the money from the account. The benefits of a credit-builder loan are twofold. You’re building a savings account while also building your credit history.
These loans aren’t usually large. Most are within the $500 to $1,000 range. They’re designed to be reasonable to pay back. With interest, you will end up paying more than the original amount. But, the extra amount you pay is small compared to the potential benefits of improved credit. Better credit scores are usually eligible for more loans, better terms and better rates. It works like this:
- You make payments on the loan over time. A common loan requires monthly payments over a year or two.
- The money is held in an interest bearing account – The lender puts the money in savings account under their control.
- Your Payment progress is reported to the three major credit reporting agencies
- You get the money once the loan’s fully paid.
Will a credit builder loan really improve your credit scores?
Credit-builder loans can definitely improve your credit score, but it really depends on you. Lenders report payments on these loans to credit bureaus. If you make your payments on time, this builds positive payment history. For example, 35% of your FICO credit score is determined by your on-time payment history. So, keep in mind that if you’re late making a payment, that’ll be reported, too. When you don’t have much of a credit history, a single late payment can be a big setback. But, the flip side is that a year or two of ontime payments can boost your credit score – significantly.