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If you are trying to improve your credit, then a credit builder loan can be a good option. However, before you apply for one, you need to understand both how they work and who they are best for.
Improving credit can take years while you wait for negative remarks to fall off your credit report. But with a credit builder loan, instead of taking a passive approach waiting for updates on your report, you can take an active approach that will help build your credit.
So, let’s take a closer look at credit builder loans. Specifically how they work and how they can help you improve your credit score.
What is a credit builder loan?
When you are trying to build credit, it can be difficult to find a lender that is willing to work with you. That’s because a non-existent or low credit score indicates to a lender that lending money to you is a risky undertaking based on your past financial decisions.
Without the opportunity to prove that you are ready and willing to handle a loan responsibly, lenders may never realize that you are a good borrower to work with.
A credit builder loan can help you out of this cycle. Instead of waiting for new reports to be added or past mistakes to fall off your credit report, you can actively pursue a better credit score with this type of loan.
A credit builder loan allows you to take out a loan where all the loan funds are deposited into an FDIC insured bank account. The funds stay in the bank account for the duration of the loan, so you won't have access to them until you pay off your loan. This essentially acts as collateral. Once the loan is paid off, you'll be granted access to the funds in the bank account.
When you take out a credit builder loan, it is typically for a short-term period between six months and two years. The loan is designed to be less risky for the lender, so it is more likely that they will be willing to work with you.
How does a credit builder loan work?
Throughout the loan term, you’ll make monthly installment payments. As mentioned, at the end of the term, the lender will give you the funds that were initially stashed in a bank account.
It is important to note that you will only receive these funds if you repay the loan. If you default for any reason, the lender will have the right to keep the original loan amount in the bank account.
As you pay off a credit builder loan, it might feel like you are putting money away in savings. And that's because you are! When you get the funds at the end of the loan term, you’ll enjoy the lump sum payment of your loan amount.
Overall, a credit builder loan offers two benefits. First, you’ll earn a credit boost if you make your payments on schedule. Second, you’ll receive a boost to your savings at the end of the loan term.
Will a credit builder loan really improve your credit?
A credit builder loan is reported to the credit bureaus which keep track of your credit history. In the US, three major credit bureaus keep track of your history: Equifax, Transunion, and Experian. The reports held by these bureaus form the base of your credit score.
One of the biggest factors that affect your credit score is whether or not you make on-time payments to your loans. With a clean payment history, your credit score will start to rise.
With that, a credit builder loan can truly help you improve your credit score. But you’ll need to make on-time payments throughout the course of the loan.
If you aren’t able to make on-time payments to your credit builder loan, then you might end up hurting your credit score.
How much do credit builder loans cost?
Like all loans, credit builder loans have several costs associated with them. Keep these in mind as you consider your options.
- Interest payments. As you make payments to your loan, part of your payment will cover the interest of the loan. This is money that you won’t get back at the end of the loan term.
- Fees. Most credit builder loans will involve a startup fee. But some will also include other fees along the way. As you consider your different loan options, make sure to take these fees into account.
- APR. The APR on a credit builder loan will include the total interest rate plus the effect of any fees. Keep an eye on this number as you shop around for credit builder loans.
Where to get a credit builder loan
Although there are many credit builder loan companies, Self (formerly Self Lender) is one of the best.
Plus, you’ll have the option to choose a monthly loan payment amount between $25 and $150. The size and length of the loan will depend on your credit-building goals and your budget.
Take some time to shop around for the best fit for your situation. As with any loan, take a minute to compare the APRs and fees attached to each loan.
Additionally, check out customer reviews to make sure that you feel comfortable with the lender. Once you have found the best option for you, then take action!
As you consider your options, weigh the pros of building credit against the costs. If you’d like to find out more about Self, then check out our full review.
Who should use a credit builder loan?
A credit builder loan is a great way to improve your credit score. With a good credit score, you have the opportunity to secure attractive financing for a variety of loans.
For example, you may want to purchase your first home in the future, a good credit score can help to make that dream an affordable reality.
If you want to improve your credit and are willing and able to make on-time payments, then this type of loan might be a good option for you. Before you get started, take a look at your budget. Make sure that you are able to support on-time payments before moving forward.
Who shouldn’t use a credit builder loan?
Although there are many benefits to a credit builder loan, there can be negative consequences. If you aren’t in a position to make on-time payments, then you might end up hurting your credit.
Beyond the possibility of hurting your credit score, you may not need to consider this option if you don’t want to pursue large purchases through financing in the future.
If you plan to make all of your large purchases in cash, then you might not need the boost of a good credit score. However, making large purchases in cash can be extremely difficult for most people.
Think about the real possibility of being able to purchase a home or your next car in cash before disregarding this opportunity. After all, it never hurts to have a good credit score to support your finances.
The bottom line
Credit builder loans can be a good financial tool. But only if you are able to keep up with the payments. Otherwise, you’ll end up back where you started with bad (and potentially worse) credit.
With a good credit score, you can enjoy the opportunities of better financing for many major purchases. Don’t wait to pursue a credit builder loan.
If you want to improve your credit score and have the ability to make on-time payments, then move forward today!