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 (new to credit). In the current market scenario, a healthy Credit Score is important to avail credit facilities from majority of Banks and Financial Institutions. Hence, an unhealthy credit score may adversely affect a customer’s probability of availing fresh credit from the financiers.
The Credit Builder Program is a program which lends a helping hand to customers who:
- Are Willing to clear their existing overdue
- Are Looking for a new credit line
- Are Interested in improving their credit history and credit score
- Don’t have credit score due to lack of any loan or Credit Card
How does a Credit-Builder Loan Work?
Credit-builder loans are typically offered by small financial institutions, such as credit unions and community banks.
When you get a credit-builder loan, the money you agree to borrow is deposited into a bank account held by the lender. You’ll then make monthly principal and interest payments which are reported to credit bureaus for a term usually around six to 24 months. When the loan is paid off, you get the money from the account.
The benefits of a credit-builder loan are twofold: You’re building a little nest egg while also building credit.
Ways to Build Credit Score
Timely Payment: Ensure that the due amount is paid within the set duration. This is the most important metric for your credit score.
Ask For A Higher Credit Limit: If you have a higher credit limit and your usage remains consistent, you lower your credit utilization ratio which helps improve the credit score.
Dispute Errors: Keep a constant check on your credit card statement and dispute any errors or wrong charges.
Mix It Up: Mix up your credit sources. Try incorporating different kinds of credit to improve your creditworthiness.
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.
Benefits of Getting a Credit Builder Loan
- Line Of Credit: Banks do not provide loans to people with a low credit score or no existing credit history. But they can easily secure a line of credit using a credit builder loan.
- Build Credit Score: A credit builder loan helps you build your credit score and later avail benefits of credit from banks at lower interest rates.
- Improve Credit Score: For people with a low credit score, a credit builder loan can help significantly improve their credit score.
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
Why Should You Use A Credit Builder Loan?
A credit builder loan can be used for a number of reasons, some of which are discussed below
- Helps Kick-Start Credit: Starting the process of building credit is extremely tedious. Groups such as fresh graduates, immigrants, or generally people with no credit history or a bleak credit history can benefit greatly from a credit builder loan. Also, in many cases, a credit builder loan may be the only source of credit available to people with no pre-existing credit history.
- Helps Improve Credit: A credit builder loan can help build the credit score without the additional risk of taking on large amounts of debt. With an improved credit score, one can avail of various benefits such as lower interest rates on loans, higher credit card limit, and many others.
- Helps Rebuild Credit: Life is unpredictable and change is the only constant. Unforeseen events such as bankruptcy, divorce, health ailments can put a dent in the credit score. In such a scenario, getting a credit builder loan presents a way to rebuild the credit score from scratch.
How much does a Credit-Builder Loan Cost?
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.
How to avail Credit Builder Loan
Taking into account the situation of the individuals, Credit Builder Loans are designed by many banks or financial institutions. You can avail these loans quite easily following the steps as given below.
- Approach a lender who offers credit builder loans
- As you do not have a credit profile or have a bad one, the lender will look for other data points like your social media profile, bank transactions, etc to build your credit profile, which can help them make the lending decision
- At times, banks may insist on lending only to those who have an account with them to reduce risk
- These loans work like normal personal loans, but the amount that can be availed as a loan is quite small
- The tenure of these loans is also shorter than normal personal loans, often ranging between 6 months to a year
- Once the loan is disbursed, you start making regular EMIs like a normal loan
- When there are regular EMIs being paid, the same is reported to the credit bureaus and will see an improvement in your credit score too.
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.
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.
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.
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.
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.
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.
Will a credit-builder loan really improve your credit scores?
Whether credit-builder loans improve your credit depends on you.
Lenders report payments on these loans to credit bureaus. If you make your payments on time, this builds positive payment history, which, for example, accounts for 35% of your FICO credit scores. But if you’re late making a payment, that’ll be reported, too. And when you don’t have much of a credit history, a single late payment can be a big setback.
The drop in your scores depends on where you started and your current credit but myFICO reports that your FICO scores could fall as much as 60 to 110 points. That’s a lot when you consider that the FICO scores range is 300 to 850.