Credit Builder Loans

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What Is a Credit-Builder Loan?

A credit builder loan is an excellent way for someone with either little to no credit or someone with extremely poor credit, to either build a credit history or rebuild a broken one. Many lenders offer credit builder loans as a way to build or repair a credit history as an alternative to taking on debt in the form of a credit card or a personal line of credit.

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There are plenty of loans that can help someone build credit. Some common loan types that build credit are auto loans, mortgages, student loans, personal loans, installment loans, and credit builder loans

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What is a credit builder loan?

When you take on a credit builder loan, you are essentially making payments towards a savings account that a lender sets aside for you. Once you reach the predetermined amount, the total amount, and typically some or all of the interest you paid, is returned to you in one lump sum. The predetermined amount is agreed upon between you and the lender when you apply for the credit builder loan. You then will agree upon the length of the repayment period.
As you make the monthly payments on time each month, the lender will then report each on-time payment to all three credit reporting agencies. Some credit builder loans may require interest payments whereas others may not. If the lender charges interest on the loan and calculates that interest into your monthly payments, the lender may either return all or part of the interest once the loan repayment period ends and the total goal amount is achieved. Be sure you understand the complete terms and conditions of the start loan before you begin to ensure you understand the interest portion of the loan specifications.

Do personal loans build credit?

Yes, when someone takes out a new personal loan, they are adding to their overall debt, however, they are also potentially diversifying their credit mix as well as establishing a payment history. As the loan continues to be paid, and the monthly payments are being made on time and in full, then a person can build a positive payment history while they lower their overall debt amount. Payment history accounts for 35% of a person’s credit score, therefore, a personal loan that shows a 100% positive payment history, that is eventually paid in full, can do wonders to help an individual build their credit profile.

Do all loans help build credit?

Yes, most, if not all loans help to build some sort of credit by allowing a borrower to establish a payment history. However, loans can sometimes do the opposite of helping to build credit. Sometimes they can help to destroy credit. If a borrower decides to take on a personal loan and they begin to submit late payments, miss payments, and/or eventually default on the loan, the borrower’s actions can be disastrous on a credit report. A loan default can drop someone’s credit score on average anywhere from 90 to 110-points. Additionally, the loan default may appear on a credit report for up to 7-years making it extremely difficult to obtain new credit in the future.

What types of loans build credit?

There are plenty of loans that can help someone build credit. Some common loan types that build credit are auto loans, mortgages, student loans, personal loans, installment loans, and credit builder loans. Also, using a revolving line of credit like a credit card or a personal line of credit can also build credit as long as all payments are made on time and as long as debt balances are kept below 30%.

Is a credit builder loan a good idea?

There are many scenarios where a credit builder loan may be a good idea. Being proactive about establishing credit can help you later in life when you may need credit. As with any loan, just be sure to understand the terms before committing.

How many points will a credit builder loan raise my credit score?

It is estimated that a credit builder loan could raise the average credit score of a person who has little to no previous credit history or debts by 60 points when compared to people with similar credit profiles who did not take out a credit-builder personal loan.

Do banks offer credit builder loans?

Yes, some banks may offer credit builder loans, however, they may be more common among smaller financial institutions like credit unions and community banks. There are some online lenders who may offer credit builder loans as well.

How does a credit builder loan work?

When you apply for a credit builder loan, the lender places that amount into a savings account for you. For example, you could apply for a $2,000 credit builder loan. You and the lender then determine a loan term and split the $2,000 into monthly payments. The lender may or may not charge interest on the loan, and if they do, they may keep a portion of the interest as payment for services or they may return all of the interest paid back to you once the loan term is complete. This detail can vary by lender, therefore it is extremely important you understand all the conditions of the credit builder loan before signing.
Let us say you take out a credit builder loan for $2,000 over 12-months with a 10% interest rate. Each month you can make the monthly payments of $183.33 to the lender, and at the end of the 12-month repayment period, you should have reached around $2,200. It is at this point that the lender may wire you the $2,200, or they may wire you a less amount no less than $2, 000 if part of the conditions of the credit builder loan is that the lender gets to keep a portion of the $200 of interest accumulated as a service fee. At the end of the 12-month period, you should have 12-months of successful and positive payment history that should have helped boost your credit score enough that you may be able to qualify for a different line of credit on your own.

Do you lose money with a credit builder loan?

Each lender is different and the terms and conditions of credit builder loans can vary. Some lenders may want to keep a portion of any interest paid on the credit builder loan as a payment for their services. Always check with the lender to understand what their credit builder loan program entails before signing onto one.

How long does it take to build credit with a credit builder loan?

Typically, it can take a minimum of 6-months of payment history and/or credit activity to establish enough history to impact your score. If you only have a small credit builder loan, you may not see much of a change but it should lay the path to qualify for other types of credit. Establishing a good credit score requires awareness and attention. No effort you make is worthless, so keep making good financial decisions and working on boosting your score.

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