A credit builder loan is a specialized loan that is designed to cater to the need of anyone who is looking at improving their low credit score or build up a credit profile. A credit-builder loan is designed to help people who have little or no credit history build credit. A good score makes approval for credit cards and loans, at better rates, more likely. Credit-builder loans do not require good credit for approval. They do require that you have enough income to make payments.
How does a Credit Builder Loan Work?
An individual with a low or no credit score often finds it difficult to make eligible for any credit product. And like a chicken and egg situation, without an access to a credit product, there is no way you can build or open your credit score. There are other options like a loan against a Fixed Deposit or a Secured Credit Card. However, many times, the applicant may not have an asset against which he can draw a loan.
Who can take Builder Loan?
A credit builder loan is especially helpful for the following groups of people
- People looking for a fresh line of credit
- People who want to improve their credit history and credit score
- People who do not have any existing credit score
- People who want to clear their existing loan advances
How to Get a Credit-builder Loan
If you think a credit-builder loan may be a good fit, follow these steps to get the process started.
1. Identify Lenders That Offer Credit-builder Loans
Not all lenders offer credit-builder loans, so the first step is identifying lenders in your community or online platform that are willing to help. Start by contacting your local bank or credit union, or consider an online lender.
2. Determine How Much You Want to Borrow
When shopping for a traditional loan, it’s important to consider how much you need to borrow to cover your upcoming expenses. However, in the case of a credit-builder loan, the question becomes how much you’re willing to commit to your loan account, and by how much you want to improve your credit score.
3. Shop around for the best Terms
Credit-builder loans are intended for borrowers with low credit, but terms often vary by lender and borrower income and creditworthiness. In general, though, the APR is between 6% and 16%. If you’re considering a lender, see if it offers a prequalification process that lets you check your rate without a hard credit inquiry.
Lenders also may charge fees, including for administrative costs or late payments, so check the lender’s policies before signing on the dotted line. Also confirm that the lender reports to all three credit bureaus Equifax, Experian and TransUnion. This will ensure you get the maximum benefit from making on-time payments on your credit-builder loan.
4. Submit a Formal Application
Once you choose a lender, familiarize yourself with its loan application process and collect all of the documents you’ll need. Often, this includes contact information, identification and proof of income, but the requirements vary by lender.
How to manage a Credit-Builder Loan?
1. Pick the right type of Credit-Builder Loan
Look for one with a payment you can comfortably afford. Stretching your budget will only raise your risk of missing a payment and damaging your score.
2. Make payments on Time
If you pay the loan as agreed, you build up good data on your credit reports. But a payment more than 30 days late will also go on your reports and can seriously hurt your score.
3. Monitor your Credit Score
Use a personal finance website to get a free credit score. Decide what to do with your loan proceeds, plus any interest. At the end of the loan term, you get the money and likely a better credit score. If possible, use that money as an emergency fund. Having even a few hundred dollars saved can insulate you from unexpected expenses that otherwise might lead to debt or missed payments and score damage.
Alternative Ways to Build Credit
Credit-builder loans aren’t the only way you can improve or build your credit history. If a credit-builder loan doesn’t seem to fit your needs, consider using an alternative, including:
- Secured Credit Cards
A secured credit card is one where the credit limit is dictated by how much the borrower commits as a security deposit. These cards are primarily a way for borrowers to build their credit and don’t offer rewards or competitive rates.
- Secured Loan
Like secured credit cards, secured loans are collateralized by something of value like your home or auto title. Secured loans present less risk to lenders than unsecured financing, so it may be easier to qualify with a low credit score and build your credit from there.
- Act as an Authorized User
Being an authorized user on someone else’s credit card involves the cardholder adding another person’s name to his account. The authorized user is not the primary name on the account, but they can still use the card to make purchases and build credit assuming the primary cardholder makes on-time payments and maintains a low credit utilization rate.
- Personal Loan with a Co-Signer
A loan co-signer is someone who provides a guarantee those someone else’s debts will be repaid. Typically, a co-signer has a higher credit score than the primary applicant, which makes it easier for borrowers with poor credit to get approved for a loan. Once approved for a co-signed loan, build your credit score by making on-time payments and keeping your credit utilization rate low.
How much does a Credit-Builder Loan cost?
Costs of a credit-builder loan vary depending on the lender. When looking for your loan, pay attention to
- The APR: APR, or annual percentage rate, is the amount your lender charges you to borrow the funds. An APR of less than 10% is common with credit-builder loans, but some have higher rates.
- Interest Payments: Lenders offering credit-builder loans may keep some or all the interest you pay, giving you only the remaining balance at the end of the loan term.
- Other Fees and Costs: Lenders may charge an application fee for the loan or charge late fees if you don’t pay on time.
- The Loan Repayment Term: The longer your loan term, the more interest you’ll pay.
- Maximum and Minimum Loan Limits: You don’t want to borrow too much or too little. If you borrow a larger amount of money it could take you longer to pay back, which means paying more in interest.
What are the Types of Credit Builder Loans Available?
The kind of loan being made available may vary among lenders and a single lender may not even have all these kind of loans.
1. Pure Credit Builder Loan
In this kind of a loan, the amount availed as the loan is kept away in a locked savings account to which the borrower has no access to. However, the amount is repaid as EMIs over the pre-decided tenure and interest. At the end of the loan period, the entire amount along with interest is paid back to the lender. The bank may, however, charge a small fee for making the entire arrangement and reporting your prompt repayment.
2. Secured Credit Builder Loan
Under this arrangement, the amount in your existing savings account is secured against the loan availed. This remains locked until you pay back the loan. The rate of interest is lower here, but you should bear in mind that the amount in your savings account cannot be used till the repayment of the loan.
3. Unsecured Credit Builder Loan
This is the common version of the loan that is generally available. Here, the loan amount is made available to the borrower as usual and he makes the repayment as per the schedule. However, this loan carries a higher rate of interest than normal loan.