Credit-builder loans hold the amount borrowed in a bank while you make repayments, thus building credit.
Credit-builder loans are designed to help those with poor credit histories or little credit build credit. Good credit scores make it easier to get loans and credit cards at higher rates.
For the approval of credit-builder loans, you don’t need to have good credit. However, they do require you to have sufficient income to pay the monthly payments.
These loans are a great option for credit novices and “credit invisible”, as they can help them get on the credit score radar. Existing debt holders are unlikely to benefit as much. An analysis by the Consumer Financial Protection Bureau of approximately 1,500 consumers in 2020 found that participants with no existing debt had credit scores that were 60 points higher than those with existing debt.
What is a credit-builder mortgage?
Credit-builder loans are also known by different names such as “Fresh Start Loans”, or “Starting Over Loans.” These loans are not well-known and are usually offered by smaller financial institutions such as credit unions or community banks.
The amount you borrow will be held in your bank account until you pay the monthly payments. You won’t be able to access the money until the loan is fully paid off. This allows you to save money and build credit simultaneously. This serves as a safety net to the lender who is taking on risk if your credit history or credit rating is not good.
At least one credit bureau reports your loan payments. Credit scores are built using information from your credit reports. The three major credit bureaus compile them. As long as you pay your bills on time, having your payments reported can help build credit.
It is important to pay your credit-builder loan on time. This shows that you can manage a credit card account. FICO credit scoring models and VantageScore credit scoring systems pay the most attention to the payment history of your credit reports.
How to manage a credit-builder mortgage
Choose the right credit-builder loan type. You should choose one that you can afford. Extending your budget can increase your chances of missing a payment, which could lead to a lower credit score. NerdWallet suggests that you choose a reasonable loan amount and a term of no more than 24 months. You should choose a loan that reports all payments to the three major credit bureaus.
Pay your loan on time. You will build good credit scores if you make your payments on time. A payment that is more than 30 days late can also be reported on your credit reports, which could seriously impact your credit score.
Check your credit score. To get a free credit score, use a personal finance website like NerdWallet. NerdWallet keeps you updated on your score every week. You can watch the overall trend, but not obsess about small movements.
You decide what you will do with the loan proceeds and any interest. You will receive the money at the end of your loan term. This will likely result in a higher credit score. You can use this money to build an emergency fund if you are able. Even a few hundred dollars can be enough to protect you from unanticipated expenses, such as missed payments or debt.
Where can I find a credit-builder mortgage?
Credit unions and community banks: It can be difficult to find a credit-builder loan. Search online for “credit-builder loans” to find nearby credit unions and community banks that may have credit-builder loans. Credit unions usually require you to live in a specific area, work for certain companies, attend a particular church, or make a small charitable contribution. They may not offer the best interest rates. It is worth checking.
CDFIs: You might consider a Community Development Financial Institution if your bank or credit union doesn’t have them. There are approximately 1,000 of these organizations in the United States.
Online lenders: A quick internet search will bring up lenders offering credit-builder loans. It’s important that you verify that every lender is licensed in your state. Additionally, APRs, terms, and payments can vary greatly.
Lending circles: A credit-building plan that is offered by lending circles can be shared among friends and families. A lending circle program is run by Mission Asset Fund, a non-profit organization. Participants receive interest-free loans that are “social”, with the payments being reported to credit bureaus. Limited availability. Other companies offer different versions of lending circles.
These groups consist of around 10 people who each agree to contribute a set amount each month. The money then goes to one person in a round-robin manner each month until everyone has received a lump sum.
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There are other options available for building credit
You may be able to get an installment loan if you have cash in the bank. A deposit that you have already made at the bank is used as collateral. This money is kept frozen until the loan is paid back. Or it can be thawed incrementally, depending on how the loan is being repaid. It may be worthwhile to ask if your bank or credit union has funds that you can borrow against. You may be able to borrow against your car’s value through other lenders.
You could ask a close friend or relative with excellent credit to add your name as an authorized user on your credit card. You will receive a credit report that includes the card’s account history. You don’t have the card to give them, nor do you need to pay any fees. Your credit score will be enhanced by being associated with your excellent credit history.
Secured credit cards can be another option for building credit. However, they do require an upfront deposit of $200. Alternative credit card products are also available that don’t require deposits.
An unsecured personal loan is best if you’re trying to improve your credit score and require immediate funds (e.g. to consolidate debt). This means that the lender does not have any collateral other than your credit history. You’ll be charged higher interest rates if your credit history is poor or damaged. This can sometimes reach as high as 36% for personal loan lenders who check credit.
There are lenders that will approve you for unsecured personal loans, without checking your credit. However, these installment loans function more like payday loans. Lenders may not report payments to credit agencies, so they might not be useful if your goal is to build credit.
