Banking and Finance

What is A Credit Builder Loan and How It Helps Build Your Credit

Nan
April 23, 2022

A credit-builder loan is designed to help people to improve their credit scores. Have a poor credit score, or don’t have a credit history at all? A credit-builder loan would be a great choice for you. 

Different from a traditional loan, a credit-builder loan asks you to make fixed payments into a bank account ahead of time. At the end of the loan term, you will get the money back, and potentially, with the interests you paid. The lender will report your on-time payments, which helps to build your credit. 

Want to learn more about how to build credit or repair bad credit? Read on this article, we’ll tell you the things you need to know about credit-builder loans. 

  1. How does a credit-builder loan work? 
  2. Why does a credit-builder loan help to build your credit?
  3. Tips for managing a credit-builder loan.
  4. More options to build or rebuild your credit. 

How does a credit-builder loan work?

A traditional loan gives you the money you’re borrowing upfront, and then you pay it back over time. In this way, lenders face a relatively high risk of not getting the money back, so they require good credit scores. A credit-builder loan holds the opposite logic. Here’s what happens after your credit-builder loan application is approved: 

  1. The lender holds the money in a credit-builder account. The lender will hold the loan money in a secured savings account or a certificate of deposit, in your name. According to the Consumer Financial Protection Bureau, the loan amount normally falls from $300 to $1,000. 
  2. You make monthly fixed payments. You will make monthly payments - both the loan principal and interest - to the lender. The loan term is usually around 6 to 24 months.
  3. The lender reports your payments. The lender will report your timely payments to at least one of the major credit bureaus, TransUnion, Equifax, and Experian. 
  4. You receive the money. After your full payments to the whole loan term, the lender will release the funds to you. Sometimes the money comes with the interest you paid, but this differs by lenders.

Because you make payments before you get the loan money, lenders face lower risks. Therefore, they don’t need you to have a high credit score as proof of your financial ability. They can lend you money with no credit check.  

Why does a credit-builder loan help you build credit? 

A credit-builder loan offers you an opportunity to prove your capability of making on-time payments. It reports these timely payments to the major credit agencies who collect your credit data and form your credit report. This can help you build positive credit because the payment history on your credit report is a significant factor in calculating your credit score. The most popular credit scoring models FICO and VantageScore both see payment history as the biggest contribution to a credit score. For a FICO score, payment history accounts for 35%; for VantageScore, payment history accounts for 40% of the credit score. 

 Picture source: myfico.com; nerdwallet

Remember to make your payments on time! Because your lender report all your payments - timely payments, late payments, missed payments - to the credit bureaus. Late and missed payments will hurt your credit score. 

Tips for managing a credit-builder loan

1. Compare different lenders and choose the best credit-builder loan for yourself. 

The loan amounts, interest rates, loan terms, how your payments get reported, and other fees vary among credit-builder companies. You may start from these great credit-builder loan companies: Self, CreditStrong, Alltru Credit Union

2. Choose the loan amount that you can cover. 

Credit-builder loan limits usually vary from $300 to &1000. A larger amount makes you repay more every month. Only borrow the amount you can afford; otherwise, it will even hurt your credit if you fail to make the payments. 

3. Make sure you make full payments on time. 

Remember, the credit-builder loan companies not only report your timely payments but also report your late and missed payments. If you fail to do this, it will cause negative information on your credit report, thus hurting your credit score. 

More options to build or rebuild your credit

1. A personal loan

Personal loans include secured personal loans and unsecured personal loans. A secured personal loan requires collateral, in case the borrower doesn’t repay the loan as agreed. Therefore, there is a risk that you lose the collateral, which could be your house. An unsecured personal loan is likely to charge high-interest rates, but they could accept bad-credit applicants. 

2. Become an authorized user

Ask a family member or a friend to add you as an authorized user. After that, you can make payments but are not responsible for paying the debts. The payments history of the credit card account will show up on your credit report, which helps you build your credit. Besides, there is normally no credit check to become an authorized user. If there is negative information in the payment history, you can also request to remove this account from your credit report. However, not all credit issuers report an authorized user’s account to the credit bureaus.

3. A secured credit card

To get a secured credit card, you are required to deposit your credit limit. The amount usually varies from $200 to $2,000. This reduces the creditor’s risk of the borrower not paying off the loan so a poor credit score is accepted. Usually, the deposit is refundable. Remember to check whether the credit card company reports your secured credit card payments to the credit bureaus. Without this, you can’t build your credit. 

4. Try Cheese Credit Builder

Luckily, we have a better choice for you! Cheese is working hard to bring you a new credit-builder product. Stay tuned for easy and safe ways to improve your credit!