In case you weren’t aware, building your credit score is a necessary part of life in modern society. If you want to buy a car, a house, or some other significant purchase, then your credit must be in good shape. There are many ways to build credit and credit builder loan is on of those options.
Unfortunately, most people don’t have the best credit, which can severely limit the options available. Thankfully, however, improving your credit score can be as simple as getting a credit builder loan.
Today we’re going to dive into the world of credit builder loans – what they are, how they work, and whether they’re a good option for you.
How Does a Credit Builder Loan Boost Your Credit?
If we want to understand how these loans can help your credit score, it’s best to know what the three credit bureaus pay attention to when assigning a score to you. Knowing what factors lenders look at on your credit report is an important personal finance lesson. There are a handful of different factors at play, so let’s look at them one by one.
First, let’s find out what is a credit builder.
What is a Credit Builder Loan?
Technically speaking, this isn’t a loan in the traditional sense. With most loans, you’re borrowing money from a lender, which you have to pay back within a specific time frame. However, in this case, what you’re doing is paying into a savings account. The terms and conditions of the “loan” are similar to any other that you would do, except for one critical difference – in the end, you get to keep the money.
Working with your financial institution, you can set a predetermined amount of money to pay for the loan (i.e., $5000), and a minimum monthly amount. The funds go into your savings account, meaning that you get to keep all of the money you’ve paid. It’s like a contract forcing you to save money.
There are two types of credit builder loans you can get: pure credit builder loans and share secured loans.
Pure Credit Builder Loans
The way this option works is that the lender will put the total amount of a loan into your savings account. You make monthly payments until you’ve paid the whole amount, after which all of the money is yours to keep.
In many cases, you can then use this total as a deposit on a secured credit card, or as a down payment for something else (i.e., a car). What’s nice about this loan as well is that there is no minimum deposit to get started.
Share Secured Loans
In this case, rather than having the lender provide all of the funds into your saving account initially, you are the one making a deposit. For example, if you have $2000 available, you can put it into a shared secured loan savings account, where the money will be frozen.
Unlike a pure credit builder loan, payments you make will unfreeze an equal portion of the “loan”. So, if you’re making $200 payments each month, both the payment and $200 of the balance will be available to you immediately.
Typically speaking, these are short-term loans, assuming that you don’t have a ton of money to put into a savings account. However, they can still boost your credit by several points, which can make a substantial difference if you’re on the edge of going from “fair” to “good” on your credit score.
The List of the Most Important Factors Which Lenders Look at
One of the most significant loan factors that can impact your credit is making payments on-time. Late payments can penalize you and lower your score, particularly if you make a habit of doing it. Overall, if you can prove that you’re always on time with repayment plans, your credit will be relatively stable.
As you can imagine, this is one of the primary reasons why a credit builder loan helps boost your rating. By making payments on these loans regularly and on time, the bureaus will see that you are more reliable.
Let’s say that you have $10,000 available in various credit cards or lines of credit. If you’ve used up 90% of that money, then you will be seen as high risk. On the other hand, if you’ve only used 10% of your available credit, your rating will be better because it shows that you can manage your credit more efficiently.
Every time you open a new credit card, get a car loan or borrow money from a lender, that’s a new account on your credit history. The bureaus don’t like it when you open a bunch of new accounts in a short period, as it can signify that you’re not able to manage credit well.
Overall, you want to minimize the number of new accounts, as well as the total amount. So, if you have five credit cards, closing one of them can help improve your score slightly.
The other thing that the bureaus pay attention to is the duration of an account. The longer an account is active without any problems (such as late payments), the stronger it will appear on your credit.
As you can see, getting a credit builder loan can help in a variety of ways. However, the most significant method is that it will showcase a history of making payments on time. The best way to ensure that you get the most out of your credit builder loan is to set up automatic minimum payments so that you never miss one. Then, if you can add more during the month, you can pay it down faster.
Pros of Credit Builder Loans
In case you still needed a reason to get one of these loans, let’s outline the various benefits that they offer.
- Saving Money – since you get to keep the money once you’re finished paying the “loan,” it enables you to build a savings account. Having extra money saved is always a good thing, whether it’s $100 or $1000.
- Build Credit History – as we mentioned, the longer you establish on-time payments, the better your credit score will be. Having one of these loans can create this history, or help you undo any missteps you’ve made in the past.
- Earn Interest – in some cases, lenders will add interest to the loan, which is free money for you. You’ll want to compare plans to see which options have the best returns.
- Develop Good Habits – if you’re still new to the world of credit, getting one of these loans will help prepare you. Getting into the habit of making payments on time is going to serve you well in the long run.
As you can see, there are many different advantages to getting a credit builder loan. You’ll want to talk to your lender to find the right option for your situation. Overall, you want to maximize the potential return on your investment.
Cons of Credit Builder Loans
Although these loans are beneficial for most people, there can be some downsides. Before applying for a credit builder loan, you should be aware of these potential pitfalls.
- Fees – in some instances, lenders may charge a fee to get the loan. Also, if you miss payments, that can incur additional expenses. Sometimes, these costs are repaid once you finish the loan, but be sure that you read the fine print before signing.
- Late Payments – if you do wind up making late payments, those will be reported to the credit bureaus. If you’re worried about this, you may want to hold off or borrow less so that your minimum payments are lower.
- Added Debt – if you already have a lot of debt, then adding more to the total can be detrimental to your financial health. Not only that but if you have several monthly payments for other accounts, another one may be too much to handle.
Overall, as long as you’re aware of these setbacks and you go into the loan process with both eyes open, you should be able to avoid these problems. As with anything research will help you understand all of the details so that you’re fully prepared to face any challenges.
Who Should Use a Credit Builder Loan?
For the most part, getting one of these loans is designed to help you establish a positive credit history. So, there are two kinds of people who can benefit the most from getting a credit builder loan.
If you haven’t opened a credit card or borrowed money for a loan yet, then you don’t have any credit history that lenders can draw from when assessing risk. Unfortunately, no history is not great, as the potential for good or bad behavior is relatively equal.
High school and college graduates are a perfect example of people who will benefit from a credit builder loan. Since grads haven’t started a credit history, this kind of loan will help establish good behavior and allow them to get loans for a variety of things, like a new car.
Recovering From Financial Hardship
Perhaps you just finished getting through a bitter divorce. Maybe you need a loan after bankruptcy because your debt became unmanageable or want to establish good credit again. Regardless of your situation, your credit is in bad shape, and you need to do something to get it back on track.
If that sounds like you, then a credit builder loan may be just the thing to help build a positive credit history. If you tried to get a different kind of loan (i.e., home or auto), you would likely be turned down because of your low credit score.
However, because of the way these loans work, many lenders are more willing to offer them, since they aren’t providing money up front. Instead, you have to earn your funds through good habits.
Where to Get a Credit Builder Loan?
Fortunately, most financial institutions offer these kinds of loans, particularly credit unions. However, regardless of the lender you choose, you will want to compare loan options before signing up for anything.
Thankfully, we make it easy to shop personal loans with no credit. You can compare things like fees, interest rates, and other loan elements side by side. Because these loans can have such a significant impact on your credit score, you want to take the time to choose the best one for your needs.
You can always count on Loanry to connect you with reputable lenders and may even make the entire process a bit easier for you.
The crucial components to pay attention to the most are:
- Loan Amount – how much you will be earning by the end of the loan. Most lenders will have strict minimums or maximums.
- Monthly Payment – make sure that you can pay on time each month. Also, remember that you can usually pay more than the minimum without incurring a penalty.
- Interest Rates – although you won’t be earning a ton of free money, getting a little extra back is always nice.
- Fees – read the fine print to see how much this loan will cost you.
Alternative Loans for Building Credit
Just because a credit builder loan works in most cases doesn’t mean that it’s necessarily the best option for you. Let’s outline a few other ways that you can build credit without one of these loans.
Secured Credit Card
Unlike standard credit cards, you have to make a deposit to get one of these. Typically, your credit limit matches the deposit, so if you put in $500, that’s what you can spend. If you carry a balance on the card, then be sure to pay attention to the interest rates, as they can be higher than most other loans. Also, the funds are available immediately, unlike a credit builder loan.
Authorized Credit User
Perhaps a family member has good credit and wants to make you an authorized user on his or her credit card. The benefit of this option is that you get to share the person’s credit history. For the most part, this method is ideal for new borrowers (like high school grads) since they don’t have any history of their own.
If you don’t have a decent credit score, then you can usually obtain a personal loan when you have a co-signer who does. Both of you are responsible for the debt, but that also means that both of you can benefit from on-time payments. Before co-signing with someone, however, be sure that you are both clear on what’s expected of the other. For example, if the co-signer isn’t planning on making any payments, you need to establish that beforehand.
Other Ways to Build Credit without a Credit Builder Loans
So, keeping these factors in mind, here are the best ways to build credit, with or without a credit builder loan.
- Close Accounts – if you have five credit cards, for example, then consolidating yourself to three can help improve your score.
- Manage Your Budget – make sure that you’re not spending more than you’re earning so that you can pay off debt, rather than add to it.
- Avoid Late Payments – it’s much better to make a minimum payment on time than it is to pay more after the due date. Late payments can hurt your score a lot.
- Consolidate Debt – if possible, try to put all of your debt into one place so that you can manage a single monthly payment. Typically, it will be more cost-effective than paying each account individually.
- Avoid New Credit – wait until you’ve paid off the loans or credit cards you have before attempting to get a new one.
Building credit is one of the most valuable things you can do. Whether you’re still new to the world of borrowing or you’re trying to improve a bad credit score, a credit builder loan may be the best option.
We enable you to find lenders to get cash loans online with no credit (or bad credit) so that you can improve your rating. We make it easy to compare loans, rates, and payment schedules. Find the best one for your needs and start growing your credit score today.