“How Credit-Builder Loans Can Improve Your Credit Score”

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How Does a Credit-Builder Loan Work?

A credit-builder loan allows you to make fixed payments into a savings account over several months. At the end of the term, the lender will return to you the balance of the account―possibly including some of the interest you paid―and you’ll strengthen your credit with positive payment history.

If you have poor credit or no credit history, a credit-builder loan can help you establish a record of trustworthy financial behavior without using a credit card. Here’s what to know.

How Does a Credit-Builder Loan Work?

A credit-builder loan works in the opposite way personal loans traditionally do. Instead of receiving a lump-sum payment from a lender that you then pay off over time, the lender sets aside a certain amount of its own money in a savings account.

You then pay toward that account in monthly installments and, at the end of the loan term, get access to the balance. You’ll pay interest on the loan, but the lender may return a portion of that paid interest or the interest earned on the savings while in the account—referred to as “dividends” by credit unions—to you at the end of the loan term. When choosing a credit-builder loan, make sure you understand its interest rate, any fees you’ll pay and the lender’s policy on whether you’ll receive the interest that has accrued.

The benefit of a credit-builder loan is that the lender typically reports your payment history to the credit bureaus, helping you strengthen your credit with on-time monthly payments. You’ll also build savings you didn’t have before, making a credit-builder loan doubly useful.

Credit-builder loans generally come in increments of $300 to $1,000 with six- to 24-month terms. Say, for example, you apply for a credit-builder loan of $1,000 with a 12-month term and 5% annual percentage rate (APR) with a credit union. You’ll pay $86 per month, including $27 in interest. At the end of 12 months, your credit union will return the $1,000 to you, plus any dividends you’ve earned according to the dividend rate.

How to Get a Credit-Builder Loan

You may not need to undergo a traditional credit check to apply for a credit-builder loan. Instead of using your credit score as a baseline for approval, some lenders may use your banking history through the consumer reporting agency ChexSystems. In this case, activities like bounced checks could affect whether you’re approved for a loan.

To get a credit-builder loan, you’ll need to provide some or all of the following:

• Employment information
• Pretax monthly income; lenders may allow you to deduct any alimony or child support you receive from this total
• Pay stubs as proof of income
• If self-employed, tax returns as proof of income
• Total housing payment
• Other loan balances
• Checking and savings account balances
• References

Credit-builder loans are available at the following types of institutions:

• Credit unions: Many credit unions offer credit-builder loans; search your local institutions’ websites to see your options. You’ll need to become a member of the credit union to get a loan, and you’ll qualify based on characteristics such as where you work or where you live. To join the credit union, you’ll typically pay a membership fee of $5 to $25 or donate to a partner charity.
• Community banks: These locally owned banks may also offer credit-builder loans, and they have a focus on financial education similar to credit unions. Search for a community bank near you using the Independent Community Bankers of America’s search tool.
• Lending circles: Peer groups can help each other build credit using lending circles, which offer interest-free loans usually facilitated by a community organization. The group decides on a monthly payment and loan balance, and each member pays the same amount per month to a central fund. Every month, one member receives a loan in the agreed-upon balance. In the meantime, monthly payments are reported to the three credit bureaus. You can look up lending circles in your area using the nonprofit Mission Asset Fund’s database.

Before applying for a credit-builder loan, find out whether the lender reports to all three credit bureaus (Experian, TransUnion, and Equifax). Not all do. If your credit-builder loan appears on all three of your credit reports, it can help your credit scores across the board.

How Can a Credit-Builder Loan Help My Credit?

As a type of installment loan, credit-builder loans have fixed monthly payments. Paying them off on time contributes to healthy credit scores because payment history makes up 35% of your FICO® Score, the largest share.

Credit-builder loans help you build credit if you don’t yet have any accounts, and they can help restore credit if you have negative marks on your credit report. By making on-time payments, you’ll show lenders you can be trusted to take on other lines of credit in the future.

A good credit score—one that’s 670 or higher—has many benefits. It could help you qualify for loans that help you meet your financial goals, such as mortgages, car loans, and private student loans. It could ensure you’re offered the lowest possible interest rates on those loans, saving you money over time. It could even get you access to rewards credit cards with special perks, like cash back, which can also save you money on purchases.

Additional Ways to Improve Your Credit Scores

Getting a credit-builder loan isn’t the only way to give your credit profile a boost. You can also use one or more of these strategies:

• Opt for a secured credit card: Unlike a traditional credit card, a secured credit card requires you to make a deposit, generally $200 to $2,000, which usually becomes your credit limit. You can use the secured card like a traditional card, charging small amounts and paying your full balance each month. Over time, if you use the card responsibly, the bank may be willing to convert it to a regular unsecured credit card. Make sure the issuer reports your account activity to the credit bureaus so the card will, in fact, help you build credit.
• Join an account as an authorized user: Authorized users on credit card accounts are not responsible for making payments, but they can still use the account if the primary cardholder agrees. Payment history will appear on their credit reports. Not all creditors report authorized user accounts to the credit bureaus, though, so ask before being added.
• Apply for a secured personal loan: A secured loan is one backed by collateral, which the lender could take possession of if you don’t repay the loan as agreed. While a secured personal loan can help you build credit, the prospect of losing the collateral you put up—such as your car—could make this a riskier option than, say, a secured credit card that requires a small cash deposit.
• Apply for an unsecured personal loan: Unsecured loans aren’t backed by collateral, so they may have higher interest rates and be harder to get than secured personal loans. Lenders will look at your income, credit scores, and other financial obligations that affect whether you can repay the loan. But like secured personal loans and other installment loans, making on-time payments can bolster your credit score.

Use Experian Boost®ø. Experian Boost is a free feature that allows you to integrate eligible rent, utility, cellphone, and some streaming service payments into your Experian FICO® Score. It works instantly, and will only pull positive payment history from your bank account or credit card into your credit file. Improvements to your credit only apply to your FICO® Score powered by Experian.

FAQs

• Does Missing a Payment Impact My Credit?
• Is It Possible to Get Out of a Credit-Builder Loan Early?
• What Happens After I Pay Off a Credit-Builder Loan?

The Bottom Line

Credit-builder loans are a financial win-win. They offer the opportunity to build credit and savings at the same time, at relatively low interest rates and with the chance to earn dividends. They’re a wise choice if you’re looking for a way to kick-start your credit journey or get back on track. By improving your credit score, you’re taking one of the most meaningful steps possible to make your financial dreams a reality.

For any mortgage service needs, call O1ne Mortgage at 213-732-3074. We’re here to help you achieve your financial goals!

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