The Takeaway
Evaluate your borrowing requirements
Examine your possibility of qualifying for a loan
Look around for the most suitable loan terms
Choose a loan amount that fits into your budget
Keep assessing your credit as soon as you get the loan to check your credit score progress
What is a Credit Builder Loan?
Setting up credit is not as easy as it sounds, especially when lenders ask for your credit history before opening an account. This makes it even more challenging for the ones who are new with no prior experience in terms of acquiring typical forms of credit like credit cards, however, there are always a few alternative options.
A credit builder loan is an alternative that usually requires no credit history. This loan is specifically crafted for the ones who want to build credit by making a payment towards the loan. Remember, just like any other loan, a credit builder loan comes at a price- you will have to pay interest throughout the loan period, albeit some lenders may recompense some of the money after you are done paying off your loan.
How does a credit builder loan work?
By now you must have got an idea that credit builder loan is considerably different from a conventional loan. In this loan, you do not receive money up front, instead, the lender deposits the loan amount usually around $300 to $1,000 into a CD or savings account that you cannot get access to until you pay-off the loan. Once you fully repay your loan, then only you will get the money.
To open the loan account, usually, a one-time administration fee is required when making the deposit. Credit builder loan typically works as a secured loan in the sense that it uses money in the bank as collateral making it less risky for lenders. You may find this loan working backward since it requires borrowers to save up the money first before accessing it. Always keep in mind, the primary reason behind taking out this loan is to check your ability to make on-time payments which can later be reported to credit bureaus such as TransUnion, Experian, and Equifax.
Credit builder loans can impact your monthly cash flow, but they can be very helpful for establishing credit. Once you are done repaying your entire loan amount, you get access to the money that was initially deposited into the CD or savings account. Also, there is a possibility of receiving a portion of the interest you paid back.
Sources and parameters for credit builder loan
The primary sources for obtaining credit builder loans are smaller financial institutions such as community banks, online lenders, and credit unions. You usually will never get a credit builder loan from major banks such as Chase or Citi. 1st Financial Federal Credit Union and Digital Federal Credit Union are two sources that offer favorable terms along with low-interest rates and the ability to receive a refund on paid interest.
If you want to take out a credit builder loan, look around online to find out different options and compare their terms with one another.
Before choosing which loan to open, consider the following:
Administrative fee: you will have to spend around $10-$25 as an account set up fee.
Loan Size: take into consideration as to how much money you can conveniently put into a CD or savings account.
Monthly Payment: do take note of how much money you are capable of paying each month. Larger the loan, the higher the monthly payment would be.
APR: consider the loan rate. Usually, these loans charge a fixed interest rate- 5%-16%.
If you will get interest charges back: choose the lenders that have a policy of refunding portion of the interest charges on making timely payments.
The role of credit builder loan in improving credit score
A credit builder loan comes with a fixed monthly payment of installments just like a personal loan, mortgage, or an auto loan. The payment you make each month for your credit builder loan is reported to the credit bureaus that can aid you in establishing a credit score.
Remember, payment history plays an indispensable role in your credit score, it is very important to consistently make on-time payments on your loan so, with time, you can build an impressive credit score.
First of all, to have a credit score you will be required to have at least one account established for the last six months or more and an account that is disclosed to the credit bureaus within the last six months. The best thing about a credit builder loan is that it asks for records of your payment made in the past six months and not more.
If you have recently stepped into the world of credit, a credit builder loan can help you adopt various other good money behaviors, such as saving to reach a particular goal. Also, it can make way for other financial products such as personal loans and credit cards.
Final Words
Credit builder loans can be a favorable option to improve credit if you consistently make on-time payments and those payments are reported properly. They also make for a less costly option when it comes to the interest rate in comparison with a traditional or secured credit card. However, they are not the best choice because of the several fees and inability to obtain the money from your loan until you pay the entire loan amount. Before choosing a credit builder loan, think about other alternatives such as a secured card that gives you the option to deposit money and provide access to an extension of credit equal to the deposit.