A Guide to Credit Builder Loans

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6 minutes read

Category: Loans
Posted on: 04/20/2021
a couple sits at a desk facing a smiling man in a suit to complete paperwork for a loan

Credit builder loans are meant to help you build up your credit. There are many reasons to build up your credit. You may be looking for financing and want more approvals or better interest rates. Or you may have had a rough financial patch and need to improve a poor score. Whatever your reasons, credit builder loans can be a powerful component of upgrading or repairing your credit. When used properly by the right individuals, credit builder loans can make significant improvements to credit scores over time.

What Are Credit Builder Loans?

Unlike most forms of financing, credit builder loans do not require you to have a good credit score. Since credit builder loans are meant to build credit, they do not disqualify people with bad ratings. Instead, credit builder loans are based on whether your income is sufficient to make payments. With a credit builder loan, you take out an agreed-upon amount after making on-time payments for it. Your payments are reported to the three major credit bureaus: Experian, Equifax, and TransUnion. Credit scores are calculated from the info contained in your credit report. This means that making on-time payments has a significant impact on your credit score over time.

Credit builder loans are often called starting over loans or fresh start loans. These types of loans are generally not widely advertised. Instead, they are primarily the domain of smaller financial institutions like community banks or credit unions. Financial institutions, especially local ones, have a vested interest in you improving your credit. Doing so means you could become a potential trustworthy customer for financing later on. A credit builder loan has strict lender conditions, which will help you prove your reliability. This ensures that they do not lose out by working with you.

Are Credit Builder Loans Right for Me?

Like any form of financing, credit builder loans are not right for everyone. Those with good enough credit to get better funding are less likely to be interested in credit builder loans. However, people sometimes use them to raise their credit scores anyway since they are a less risky loan option. Another option available to those looking to build their credit is a secured credit card. Deciding how you want to build your credit is your choice and depends on what better suits your goals.

Getting and Managing Credit Builder Loans

Once you decide that a credit builder loan is right for you, you need to know how to get one. There are a few simple steps you can take to get a credit builder loan.

  1. Find the right credit builder loan. There are different kinds of credit builder loans. Each has its advantages and disadvantages. Make sure to weigh your specific needs carefully against any terms and conditions you look over.
  2. Complete the loan application. Make sure to see if you qualify for the loan you apply for. If you think you meet the criteria, fill out the application form, and send any necessary documentation (such as proof of income, etc.).
  3. Make your payments on time for every payment. This is vital. If you do not make your payments on time, you can void your loan. This can potentially cost you what you have paid up to the point you default on your loan. You can also lose money in late fees. If you ever run into unexpected trouble, talk with your lender.
  4. Watch your credit score. Many organizations exist that let you check your credit score for free, such as Credit Karma. Make sure checking will not lower your score. 
  5. Collect. Lastly, collect your loan and any accrued interest. You will receive the money once you have completed the payments. You will also likely have an improved credit rating.

Where to Find Credit Builder Loans

Look at the offers of local community banks and credit unions. You can search online for credit builder loans in your state. You can sometimes find credit builder loans available at nearby locations. Credit unions usually have requirements like being a member, living in a specific county, working for particular companies or certain industries, practicing a particular religion, or making charitable donations. Credit unions tend to offer the lowest interest rates, so be sure to check these.

If local credit unions and community banks have few or no options, you can try a Community Development Financial Institution (CDFI). CDFIs are designed to help low-income communities. There are currently about 1,000 operating within the United States. Some CDFIs, such as Capital Good Fund, make small personal loans with interest rates at or below 24 percent APR. CDFIs often offer credit builder programs for an additional cost.

Another option is online lenders. These lenders, such as Self, often offer loans with payments that start at $25 per month for two-year loans. These online lenders often have interest rates below 16 percent. As with other lenders, online lenders report your payments to the three credit bureaus. 

Along with online lenders, another less popular option is a lending circle. Families and friends can use lending circles as a credit-building plan. The lending circles program is run by the Mission Asset Fund, a nonprofit organization. In a lending circle, ten3 or so participants agree to put a specific amount into a coffer each month. Every month, this money goes to one person. This repeats monthly in a round-robin style until everyone has received the full monthly coffer. Those who receive loans receive them interest-free. These “social loans” are not available in all communities, but you can search for them using your ZIP code. Lending circles also report payments to the three major credit bureaus. 

Alternative Ways to Build Your Credit

There are other ways to build your credit that are slightly distinct from credit builder loans. For example, you can use any money you have in your bank account for either share-backed or certificate-backed loans. You can ask your bank whether you can borrow against your deposited funds. If your bank offers this as an option, your current balance becomes the collateral on your loan. That money is frozen in your account until you repay the loan. 

In some instances, banks will incrementally release some of your funds in exchange for on-time payment. Other lenders provide options like borrowing against your vehicle. Just be sure never to use something you cannot live without as your collateral. You can also try secured credit cards, though you will need enough money to pay the card’s security deposit.

You can also consider unsecured personal loans. These involve no collateral and are instead based solely on your credit history. If your credit is in poor shape, you will have a higher interest rate. These interest rates can be as much as 36 percent, so be very careful. Most reputable lenders will not ask for more than this. Steer clear of anything that resembles a payday loan, as these can have exorbitant interest rates. However, in exchange for potentially higher interest rates with unsecured loans, you can get your funds immediately. This is helpful when consolidating debt or other time-sensitive financial transactions.

Finance Guru

Finance Guru