What Is A Credit-Builder Loan? | Personal-finance | omaha.com – Omaha World-Herald

What Is A Credit-Builder Loan?

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If you don’t yet have a credit history—or you’re trying to rebuild your score—credit-builder loans, one type of personal loan, are an effective way to demonstrate your ability to make on-time payments. A credit-builder loan is solely intended to help borrowers improve their credit scores.

Instead of receiving loan proceeds and repaying the balance over time, the borrower makes fixed monthly payments into an account and then gets the money back at the end of the loan term sometimes with interest paid, minus fees.

To demystify credit-building loans, we’ll walk you through how they work, where you can find one and how to apply.

How Credit-builder Loans Work

Credit-builder loans are often thought of as the opposite of a traditional loan. Rather than a lender disbursing a lump sum of cash to the borrower at the beginning of the term, it holds money in a secured savings account or certificate of deposit (CD) in the borrower’s name until the loan is repaid. Even though the borrower doesn’t receive money up front, credit-builder loans still charge an annual percentage rate (APR), which typically ranges from 6% to 16%.

The borrower then makes fixed monthly payments against the loan principal and interest to build a strong payment history.

Over the course of the loan term, which usually extends between six and 24 months, the lender reports the borrower’s payment history to credit-reporting agencies, which can help build positive credit. Typically, loans with larger credit limits (and that are repaid in a timely manner) will help boost credit scores more because it shows a borrower’s ability to manage more debt. On-time payments increase scores while late payments hurt a borrower’s score.

At the end of the loan term, the funds are released to the borrower—sometimes with a portion of the interest.

Because the lender doesn’t disperse any funds at the beginning of the loan term, there is less risk than with a traditional personal loan. This structure makes it easier for borrowers with bad credit to access credit-building loans.

Where to Find a Credit-builder Loan

Credit-builder loans aren’t as common as traditional loans, but you can expect to find a credit-builder loan that meets your needs through:

  • Credit unions and community banks. If you already bank with a credit union, community bank or other local financial institution, contact your banker to see if credit-builder loans are available. You also can find local lenders by searching for your city or state and “credit-builder loans” online.
  • Community Development Financial Institutions. CDFIs, or Community Development Financial Institutions, are private financial institutions that are specifically committed to providing affordable financial services to low-income and disadvantaged members of the community. To find a location near you, visit the Community Finance Network’s CDFI locator or inquire with your bank.
  • Lending circles. A lending circle is a group of people who band together as a way to lend money to each other. Between six and 12 members each make a monthly payment and, every month, a different member receives the
  • Loan. And, because formalized lending circles—like those supported by Mission Asset Fund—report to credit bureaus, this option is still an excellent option for credit-building loans.
  • Online lenders. In addition to more community-based lending options, borrowers who want to improve their credit can get credit-builder loans from online platforms that specialize in helping customers increase their creditworthiness.

How to Get a Credit-builder Loan

If you think a credit-builder loan may be a good fit, follow these steps to get the process started.

1. Identify Lenders That Offer Credit-builder Loans

Not all lenders offer credit-builder loans, so the first step is identifying lenders in your community—or online—that are willing to help. Start by contacting your local bank or credit union, or consider an online prover like Self or USALLIANCE Financial.

2. Determine How Much You Want to Borrow

When shopping for a traditional loan, it’s important to consider how much you need to borrow to cover your upcoming expenses. However, in the case of a credit-builder loan, the question becomes how much you’re willing to commit to your loan account, and by how much you want to improve your credit score. Credit-builder loans typically vary from $300 up to $3,000, so take some time to review your budget before committing to a loan amount and monthly payment.

3. Shop Around For the Best Terms

Credit-builder loans are intended for borrowers with low credit, but terms often vary by lender and borrower income and creditworthiness. In general, though, the APR is between 6% and 16%. If you’re considering a lender, see if it offers a prequalification process that lets you check your rate without a hard credit inquiry.

Lenders also may charge fees, including for administrative costs or late payments, so check the lender’s policies before signing on the dotted line. Also confirm that the lender reports to all three credit bureaus—Equifax, Experian and TransUnion. This will ensure you get the maximum benefit from making on-time payments on your credit-builder loan.

4. Submit a Formal Application

Once you choose a lender, familiarize yourself with its loan application process and collect all of the documents you’ll need. Often, this includes contact information, identification and proof of income, but the requirements vary by lender.

5. Start Making Payments

Following approval for a credit-building loan, make sure you know when your first payment is due and understand how the payment must be submitted. In order for a credit-builder loan to improve your credit score, it’s necessary to make timely payments in accordance with the terms of the loan.

Tips for Managing a Credit-builder Loan

If you’re considering a credit-builder loan, consider these tips before committing to a lender:

Make Sure You Understand the Terms of the Loan

To ensure you make on-time payments and otherwise comply with loan requirements, thoroughly review the terms of your credit-builder loan before signing the documents. This includes understanding the length of the loan, APR, payment amounts and due dates.

It also extends to more complex issues like whether there are prepayment penalties, and whether you’ll receive any of the interest payments at the end of the loan. This is also a good opportunity to confirm that the lender will report your payments to the three major credit bureaus.

Only Borrow What You Can Afford

While credit-builder loan limits are typically low—from around $300 to $3,000—it’s still important to only borrow what you can afford to repay. Larger credit-builder loans have higher monthly payments, so borrowers should understand what their monthly payment will be before committing. Because the purpose of a credit-builder loan is to demonstrate an ability to repay debt, borrowing too much can damage your score if you’re not prepared for the payments.

Make Your Payments on Time and in Full

A borrower’s payment history accounts for 35% of their FICO credit score, so your score will only increase if you make on-time and in-full payments on your credit-builder loan. Typically, payments that are more than 30 days late are reported to credit bureaus and have a negative impact on the borrower’s score.

As soon as your loan is approved and you have repayment instructions, take steps to ensure you won’t miss any payments. This may be as simple as setting up auto-pay from your primary bank account or setting a reminder in your phone to make an on-time payment each month.

Alternative Ways to Build Credit

Credit-builder loans aren’t the only way you can improve or build your credit history. If a credit-builder loan doesn’t seem to fit your needs, consider using an alternative, including:

  • Secured credit cards. A secured credit card is one where the credit limit is dictated by how much the borrower commits as a security deposit. These cards are primarily a way for borrowers to build their credit and don’t offer rewards or competitive rates.
  • Secured loan. Like secured credit cards, secured loans are collateralized by something of value—like your home or auto title. Secured loans present less risk to lenders than unsecured financing, so it may be easier to qualify with a low credit score and build your credit from there.
  • Act as an authorized user. Being an authorized user on someone else’s credit card involves the cardholder adding another person’s name to his account. The authorized user is not the primary name on the account, but they can still use the card to make purchases and build credit—assuming the primary cardholder makes on-time payments and maintains a low credit utilization rate.
  • Personal loan with a co-signer. A loan co-signer is someone who provides a guarantee that someone else’s debts will be repaid. Typically, a co-signer has a higher credit score than the primary applicant, which makes it easier for borrowers with poor credit to get approved for a loan. Once approved for a co-signed loan, build your credit score by making on-time payments and keeping your credit utilization rate low.

Frequently Asked Questions (FAQs)

Can I pay off a credit builder-loan early?

Unless there are prepayment penalties or early withdrawal fees, most lenders let borrowers pay off credit-builder loans early. However, this defeats the purpose of the loan, which is to demonstrate on-time payments over an extended period of time. Still, if you find yourself in an emergency and need to access your funds, it is likely an option.

Can I get a loan with no credit score?

Getting a loan with a poor credit score—or no credit history whatsoever—is often difficult, but it can be done. If you have a low credit score, be prepared to pay higher interest rates, have a co-signer, pledge collateral or take other steps that reduce the risk to the lender. That said, if you’re applying for a credit-builder loan, it’s much easier to qualify because the lender isn’t exposed to as much risk as with traditional financing.

How can I quickly raise my credit score?

The process of raising your credit score can be lengthy and frustrating, and delinquencies stay on your report for seven years. However, you can start improving your score by keeping your credit utilization rate low and maintaining a healthy payment history. You also can take steps to improve your score by reporting inaccuracies on your report and refraining from applying for new financing that requires hard inquiries.

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