What Is a Credit Builder Loan and How Does It Work?

credit builder loan

Most traditional lenders evaluate the borrower’s credit history before disbursing any loan, which is not the case for credit builder loans. In conventional loans, the borrower receives the cash upfront and pays it over a designated period. However, in credit builder loans, one makes fixed payments to the lender and accesses the loan amount after completing paying the loan amount.

Another good thing about credit-builder loans is that one saves money while saving. Continue reading this article to understand more about what is credit builder loans and how they work. One can also check out the best personal loans to cover needs such as debt consolidation, buying a major purchase, and planning a vacation, among other financial needs.

How Does a Credit Builder Loan Work?

Credit builder loans have a different operation criterion compared to other loan options. To understand how a credit builder loan works, one needs to understand the entities and procedures involved. The lender sets us a savings account or a certificate of deposit (CD) where one makes savings for six to 24 months. According to the Consumer Financial Protection Bureau, the loan amount ranges between $300 to $1,000.

The lender reports to the credit bureaus regarding the details of the payments. They also report whether the payments are made on time which is vital when building good credit. The main credit bureaus that most lenders report to include Equifax, TransUnion, and Experian. Factors that determine whether the loan will earn interest include the type of account and the lender.

When making the payments, one cannot access the money. The funds will be available when one completes the payment during the designated loan term.

How Does It Help Improve My Credit?

A credit builder loan helps one improve their credit as it indicates that the borrower is capable of making consistent payments and on time. This is vital in building a good credit score as most lenders will scrutinize the repayment history when applying for a loan. Repayment history accounts for up to 35% of one’s FICO Score. When one makes all the payments timely during the designated loan term, this can help reinstate negative credit histories such as missed payments. In addition, it is a good way for rookies to establish a good credit score.

Where to Find a Credit Builder Loan

There are numerous options where one can get credit builder loans. However, these loan options are not common in large financial institutions such as banks. One can find credit builder loans in the following options:

  • Community banks

These are locally owned banks that work in a similar mechanism as credit unions. All that is required is to search on the nearby community banks and check how they work.

  • Credit unions

To get a loan from a credit union, one must be a member of the union. Qualifications of the loan are determined by where one lives and their occupation. One is required to pay a small membership fee or donate a partner to a charity for them to become a member of the credit union.

  • Online lenders

Online lenders have online credit builder accounts, which are similar to credit builder loans. One makes the monthly payments in the savings account. There is also a one-time sign-up fee, ranging between $9 to $15.

  • Lending circles

These mostly peer groups that a community organization runs. Their main purpose is to help people build their credit which mostly works with interest-free loans. The parameters on how the lending circle is organized by the group. This includes parameters such as monthly payments, loan balance, and a central fund fee.

How to Get a Credit Builder Loan

Credit builder loans differ from traditional loan options. This is because, in traditional loans, the borrower is given the funds upfront and pays the amount over a designated period. For a credit builder, one makes savings and gets the funds when they complete paying the loan term. Another distinguishing factor is that there is no credit score check in credit builder loans. When applying for a credit builder loan, most lenders will require the following:

  • Employment information
  • Proof of income, mostly pay stubs
  • Pretax monthly income
  • Tax returns, especially for the self-employed
  • Total housing payment
  • Saving account balances
  • Other loan balances

How to Manage a Credit Builder Loan

After understanding how a credit builder loan works and the requirements needed when applying, let’s look at how to manage the loan. Below is a step-by-step procedure that one can use when managing a credit builder loan.

1. Coming to an Agreement with a Chosen Lender

The first step is shopping around and finding a financial institution that meets the borrower’s demands. This helps in evaluating and deciding on the lender who has terms and conditions that favor the lender.

Different lenders have distinct interest charges, monthly payments amount, fees, and repayment periods. In addition, one should also confirm whether the lender reports payments to the three major credit bureaus.

2. Decide How Much to Borrow

The amount range allowed by Consumer Financial Protection Bureau is between $300 and $1,000. It is always wise to decide on an amount that one can comfortably put in a savings or CD account. Also, consider that the higher the amount, the more the monthly payment.

3. Apply for the Loan

During the application, one is required to provide basic information regarding their residence, proof of occupation, other loan and savings accounts, and any other relevant data.

4. Make the Final Payment and Qualify for the Loan

After one becomes approved, they will make the payments until they clear the intended amount. Afterward, the funds will be distributed to the borrower. In addition, one will also enjoy the benefits of an improved credit score.

Other Options for Building Credit

There are numerous options rather than credit builder loans that people can use when building up credit scores, as articulated below:

  • A Secured Credit Card

This option allows one to access a line of credit upfront, which can be used in a wide array of purchases. It differs from an unsecured credit card as one is required to pay a non-refundable security deposit for the account to be active. One is required to make a deposit roughly between $200 and $2,000, which becomes the credit limit.

The deposit stands in as collateral in case one fails to pay off the charges. After using the card responsibly for some time, the card issuer can convert it into an unsecured credit account. However, beware that missed or late payments can be detrimental to the borrower’s credit score.

  • Be an Authorized User

A family member or any other close person can add one as an authorized user to their credit card account. In this regard, one will be making the purchases while the cardholder accounts for the payments. The responsible use of this credit card account helps one boost their credit and elevate their credit scores. No credit check is required when using another person’s credit card account as an authorized user.

  • A Personal Loan

One might be wondering how to build up credit with a personal loan. But one can qualify for a personal loan despite having poor or no credit history. But the most common option is the secured personal loan that requires collateral. In case one defaults on the payments, the lender will repay it with the collateral.

On the other hand, unsecured personal loans are not backed up by collateral, but they have very high-interest rates. The lender will also look into the borrower’s income, credit score, and other financial-related concerns. Making frequent payments for both secured and unsecured personal loans will boost the borrower’s credit score.

Should You Get a Credit Builder Loan?

A credit builder loan is best for people in need of boosting or establishing their credit scores. This is because the lenders do not check the credit score when providing the loans. In addition, it helps one to make savings while building their credit scores. Credit builder loans are available in financial institutions such as credit unions, community banks, online lenders, and lending circles. However, one should choose an amount that they will be able to pay monthly as delays in payments can worsen the credit status.

Moses Will Moses Will Last update:
Moses Will is a pro in the world of finance and real estate. Having been in the field of writing for the last 12-years, he has all it takes to produce top-notch content. He is a guru in writing guides, articles, blog posts, product reviews, tech and SEO. Apart from writing, he is also a finance tutor.