A Complete Guide On Credit-Builder Loans

Are you aiming to achieve a high three-digit number when it comes to your credit score? Do you need help determining if your credit score can improve? If you’re worried about getting a loan with a bad or no credit score, rest assured that it’s possible! Your credit score significantly impacts your financial life, but if you have a bad score or no score at all, you can still use loans to build your credit. In this article, we’ll give you a complete guide on how you can do that starting today by getting a credit-builder loan.

What Is A Credit-Builder Loan?

Credit-builder loans are designed to help you improve your credit history and score. Unlike traditional loans, the money you borrow is not immediately disbursed to you, but held in a lender-controlled account until you’ve paid off the loan. This installment loan is fixed with monthly payments, similar to a personal, auto, and mortgage loan. A credit-builder loan is geared toward borrowers with low or no credit scores. Credit-builder loans also allow borrowers to improve their credit score by building credit.

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How Does A Credit-Builder Loan Work?

In order to understand how a credit-builder loan works, you first need to know the borrower requirements to qualify for a credit-builder loan:

You need to apply for a credit-builder loan. It’s unlikely that you’ll be denied for a poor credit score because these loans are designed to help you build credit.
You should have a bank account to facilitate loan transactions.
Lenders may require you to provide proof of identity and residence and a valid Social Security number.

Some lenders may also consider your credit history, although credit-builder loans are designed for individuals with limited or poor credit.

Various lenders can offer credit-builder loans, including traditional financial institutions such as banks and credit unions, online lenders, and community-based organizations. Each lender will set the loan amount aside and will put the principal funds into an earmarked account. Depending on the lender, this might be a savings according to a certificate of deposit (CD).

Once the loan amount is disbursed, the lender typically holds it in a separate account. This serves as collateral and helps mitigate the risk for the lender. As the borrower makes regular payments, the lender reports this activity to the three credit bureaus, which helps build or improve the borrower’s credit history. If you are paying your loans on time, this will soon help your credit score; however, if not, then it could hurt your credit score too. The borrower can only access the loan after they repay it, so it’s not a good decision for anyone who needs money immediately to get a credit-builder loan. Credit-builder loans are only available in small amounts, and the fees and interest rates can add up, especially if you already have a tight budget.

The borrower’s payments for a credit-builder loan are structured differently than traditional loans. Instead of receiving the loan amount upfront, the borrower makes regular payments towards the loan. These payments are usually fixed and typically last for a predetermined term, such as 6 months to 2 years. The lender holds the loan amount until the borrower completes the payment term, after which the borrower receives the funds. This unique payment structure allows borrowers to demonstrate their ability to make consistent and timely payments, improving their creditworthiness over time.

How To Get And Manage A Credit-Builder Loan

When you’re ready to improve your credit score, follow these steps to choose and manage a credit-builder loan:

1. Compare Lenders And Loan Terms

Credit-builder loans are designed for individuals with low or no credit scores. However, the terms of these loans can vary based on the lender and the borrower’s income and creditworthiness. It is essential to compare the different loan terms offered by different lenders, as they can range from 6 to 24 months, and although rare, some can even go up to 48 months. The loan term is the duration within which you must pay off your credit-builder loan. Before signing up, consider how much time you can comfortably afford for your credit-builder loan. If you are concerned about the payment, consider opting for a shorter term. Longer loan terms lead to lower monthly payments, but the annual percentage rate (APR) usually varies between 6% and 16%. The lender will attach an interest rate or APR to the loan; the higher it is, the more expensive your loan will be. Therefore, comparing and looking around for the best rates is important. Comparing lenders and loan terms is essential in obtaining and managing your credit-builder loan because lenders may charge additional fees, such as administrative costs or late payments. Also, ensure that the lender reports to all three credit bureaus (Equifax^®, Experian™, and TransUnion^®).

2. Submit An Application

Once you have completed the first step of choosing a lender, get familiar with its loan application process and collect all of the documents you’ll need to complete the application. These documents will require you to provide some personal information about yourself and your finances in order to be approved for a credit-builder loan. The documents and information required may be different depending on the lender you choose, but the standard information that you give is:

A form of identification
Your Social Security number
Date of birth
Contact Information
Your monthly rent or mortgage payment
A U.S. bank account and routing number
Proof of income

You will also need to decide on a loan amount, which is usually between $300 and $3,000. Deciding on a loan amount is purely based on what best fits your budget and needs.

3. Make On-Time Payments

Making on-time payments is another crucial step when acquiring credit-builder loans. Your payment history is one of the most critical aspects of your FICO^® Score. Since credit-builder loans provide a great opportunity to build good credit, make the most of it by committing to all on-time payments. This demonstrates to lenders that you are responsible and trustworthy, which can boost your credit score. Paying your loans on time can also help you reduce the amount of interest you pay on your loan and build trust with lenders over time. Ultimately, being consistent with your payments can help you save money in the long run and improve your credit score.

4. Monitor Your Credit Report

Monitoring your credit report allows you to stay informed about your financial standing and is an essential step when getting a credit-builder loan. Your credit-builder loan is based on your credit, so checking your credit report occasionally can ensure that all the information is accurate and current. If any errors may negatively impact your credit score, it makes it harder to qualify for a credit-builder loan. For example, if someone has used your credit card fraudulently, it can harm your credit score and your chances of getting a credit-builder loan. So, by checking your credit report for signs of fraud, you can take immediate action to protect your identity financially. It’s also important to keep track of your credit report while making payments on the credit-builder loan. By checking your credit report every so often, you can track your progress and see areas of improvement in your credit while paying off your loan. This way, you can see how your payment history is being reported. If you are making your payments on time, it helps build a positive credit history. However, if you are missing payments or submitting them late, checking your credit report can give you the necessary time to change that habit and ensure that your credit history remains positive.

5. Pay Off The Loan

The final step is to pay off your loan. Once you pay off a credit-builder loan, you’ll receive a lump sum in a separate account, although the amount may be slightly less due to interest and fees. If you’ve made your payments on time and in full, paying off the loan should have increased your credit score or at least established your credit history.

Pros Of Credit-Builder Loans

Taking out a credit-builder loan can have multiple advantages that will benefit your credit in the future. These advantages include:

Flexible borrower requirements: Credit-builder loans are made for borrowers with low credit scores and little to no credit history; therefore, lenders have more flexible requirements.
Credit-builder loans can improve your credit score: When you make your monthly payments on time, the credit bureaus are notified, and this payment history accounts for 35% of your score. So, your credit score will improve as you continue to pay on time.
Money from the loan can boost your savings: When you take out a loan, typically, you borrow money and then pay it back with interest. However, there is a type of loan where the lender keeps the money and gives it to you only when you have paid the loan amount in full, along with additional fees. This type of loan allows you to build extra savings as you won’t have access to the borrowed funds until you’ve fully paid off the loan.

Cons Of Credit-Builder Loans

While there are advantages of taking out a credit-builder loan there are some disadvantages as well. These disadvantages include:

Potential for high interest rates and fees: Lenders often impose varying standard fees, which can significantly affect your expected monthly or overall cost. While some lenders may not charge any fees, others may enforce steep charges. Fees may include prepayment penalties, application or administrative fees, and processing fees. It is essential to be aware of these fees before choosing a lender to avoid unpleasant surprises that could hurt your credit score.
Missed payments can hurt your credit score: Late or missed payments can negatively impact your credit score, even though you don’t have access to the money you’re borrowing right away. This can cause your credit score to drop, making it harder for you to obtain loans or other forms of credit in the future. Paying your bills on time is important to avoid any negative impact on your credit score.
Money can only be accessed after you repay the loan: Because credit-builder loans tend to carry repayment terms of up to 24 months, access to the loan is only received after you repay the loan. This loan is unsuitable if you are looking for fast access to cash because you must fully repay the loan to get the money.

Where To Find Loans To Build Credit

If you are deciding that getting a credit-builder loan is right for you, you might want to know where these lenders can offer you this type of loan. Lenders offer these loans at multiple areas including:

Credit unions and community banks: Credit unions are one of the most popular places to take out a credit-builder loan. They reinvest profits back into the organizations, so members benefit from lower rates on loans. Notably, community banks tend to have higher credit score requirements than credit unions.
Community Development Financial Institutions (CDFIs): CDIFs are mission-driven financial institutions that have been certified by the U.S. Department of the Treasury’s CDFI Fund.
Lending circles: Lending circles are a popular concept where a group of individuals, typically friends or family members, contribute a specific amount of money and give it to one member of the group. The purpose of lending circles is to help individuals raise money for various expenses, such as down payments, debts, and small business investments. Since lending circles are interest-free, they are one of the most cost-effective ways to borrow money.
Online lenders: An online lending network allows you to handle your personal loan process from home and compare different loan options quickly. It’s especially helpful for those with bad credit, and by applying first through the network, you can avoid the frustration of rejection and only be presented with loans that match your needs.

Alternative Ways To Build Credit

Getting a credit-builder loan isn’t the only way you can build credit. Let’s look at three alternative ways to build credit.

Get A Secured Credit Card

If you’re looking to build your credit history, using a secured credit card is an effective way for borrowers to establish and build their credit history. Borrowers put down a cash deposit as collateral, which makes it less risky for lenders. Then, by making regular on-time payments on the card and keeping a low balance it shows that you’re a responsible borrower. This then gets reported to the credit bureaus, which can help boost your credit score over time.

Become An Authorized User

If you want to build credit but want to avoid opening a credit card, a good option is to become an authorized user on someone else’s credit card. You can ask a family member or friend with a good credit history to add you as an authorized user to their credit card account. By being added as an authorized user, you can benefit from their responsible credit behavior, for instance, paying on time and keeping their balances low, which will reflect positively on your credit report. This includes their payment history and credit utilization. As long as both parties continue to manage the account responsibly, this can positively impact your credit score.

Take Out A Personal Loan

Taking out a personal loan can further help borrowers improve their credit score by showing lenders that they are good at using money responsibly. Making timely payments on a personal loan demonstrates creditworthiness and responsible financial management, which positively impacts credit scores and overall credit history.

A personal loan is a type of installment loan that allows you to borrow all the money at once and pay it back over time with interest. Unlike a credit-builder loan, you won’t have to wait until the end of the term to receive the funds. However, this is an unsecured loan which means it’s riskier to the lender, which can result in higher interest rates for the borrower.

Credit-Builder Loan FAQs

Now that we know how credit-builder loans work and what they are, let’s look at some frequently asked questions.

What is the typical credit-builder loan amount?

Generally, the typical loan amount for a credit-builder loan ranges from $300 – $3,000. This is payable within 6 – 24 months.

How does a credit-builder loan affect my credit score?

Credit-builder loans can aid you in building credit by reporting your monthly payments to the three major credit bureaus — Experian™, TransUnion^®, and Equifax^®. Your payment history accounts for 35% of your FICO^® credit score. By making timely payments, you can increase the amount of positive activity reported in your credit profile. This, later down the road, can help you establish a good credit history and improve your credit score.

Can I get a credit-builder loan without a credit check?

Yes, you can get a credit-builder loan without a credit check. You can even get a credit-builder loan with bad credit or no credit at all.

The Bottom Line: Explore All Your Options For Building Credit

As you can see, a credit-builder loan is one of many ways to build your credit. Whether you have bad or no credit, you can get a credit-builder loan to help you achieve that high three-digit credit number we all strive to have one day. If you want to receive money faster with a loan, remember that taking out a personal loan can also help you build credit.