A credit-builder loan is intended to assist those with little or no credit history in establishing credit. A high credit score increases the likelihood of approval for credit cards and loans at lower interest rates.
Credit-builder loans do not require excellent credit to get approved. They do expect you to have a sufficient income to make payments.
These loans can assist “credit invisibles” get on the credit score radar and are an excellent option for credit newcomers. Consumers who are already in debt are unlikely to benefit as much. A Consumer Financial Protection Bureau survey of over 1,500 individuals, published in 2020, discovered that credit scores of participants who did not have current debt increased by 60 points more than those who did.
What is the process of obtaining a credit-builder loan?
Credit-building loans are often known as “Fresh Start Loans” or “Starting Over Loans.” They are rarely publicized and are often provided by smaller financial organizations such as credit unions and community banks.
If you are authorized for the loan, the funds will be stored in a bank account while you make payments. You normally cannot access the funds until you have fully returned the loan, allowing you to develop both your savings and your credit at the same time. This also serves as a safety net for the lender who is taking a risk on you if you have no credit history or a low credit score.
At least one credit bureau receives information about your loan installments. Your credit score is calculated using information from your credit reports, which are compiled by the three major credit bureaus. As long as you pay on time, having your payments reported helps boost your credit.
Maintaining your credit-builder loan payments is critical because it demonstrates your ability to manage a credit account. FICO and VantageScore credit scoring algorithms place the most emphasis on your payment history in your credit reports.
How to Take Care of a Credit Builder Loan
Choose the appropriate credit-building loan. Look for one with a payment you can live with. Stretching your budget will only increase your chances of skipping a payment and lowering your credit score. NerdWallet suggests selecting a realistic loan amount and a duration of no more than 24 months. Select a loan that reports payments to all three main credit reporting agencies.