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On-time payments to a credit builder loan adds positive information to your credit report.
A good credit score can open the door to big savings on financing. It’s possible to save thousands over the life of a loan by locking in a lower interest rate, courtesy of your lower credit score.
The challenge is that building a good credit score can be difficult whether you are starting from scratch — or rebuilding a bad credit score. That’s because lenders are wary of providing a loan to borrowers with a bad credit score or without a credit history at all.
Credit builder loans provide a solution for this tricky situation. Here’s a closer look at what a credit builder loan is. Plus, how it might help your financial situation.
A credit builder loan is specifically designed to help you establish a credit score or rebuild a credit score. It creates an opportunity for building a positive payment history.
Although your payment history is just one piece of your credit score puzzle, it’s the most important factor for your FICO score. Since payment history accounts for 35% of your FICO score, this is a big deal for credit builders.
A credit builder loan is a loan product that involves regular installment payments. But there’s a unique twist.
According to the Consumer Financial Protection Bureau (CFBP), the defining feature of a credit builder loan is that borrowers start making payments before receiving any portion of the loan funds.
So, how does this loan work if you don’t receive the funds upfront?
When you open a credit builder loan, the lender opens a locked savings account earmarked for you. Although you don’t have access to the funds yet, you begin repaying the loan.
Over the course of the loan term, you will make regular monthly payments. A credit builder loan term typically stretches out for 6 to 24 months. As you make payments, the lender will report this activity to the major credit bureaus.
With each payment, the lender will deposit the principal portion of the payment into your savings account. But the lender hangs on to the interest portion of the payment for themselves.
At the end of the loan term — after successfully paying off the balance — you’ll gain access to the locked savings account. The unique setup allows you to build credit and savings at the same time.
As with all loans, there are costs to taking out a credit builder loan.
The exact costs vary based on the lender, but here’s what to look for:
And like with traditional loans if you miss a payment, you’ll typically be charged a fee. Late payments negatively affect your wallet and potentially your credit score, too.
Every financial product comes with some pros and cons. A credit builder loan isn’t an exception.
A credit builder loan could be a good fit for your finances if you want to build credit and have the bandwidth for making on-time monthly payments. If you aren’t able to make on-time payments, a credit builder loan could end up hurting your credit score.
If you don’t have a credit score at all, then a credit builder loan could help you rise from an invisible credit status. According to the same CFPB study above, participants who opened a credit builder loan increased their likelihood of getting a credit score by 24%.
Another factor to consider is whether or not you already have existing debt. In a 2020 study, the CFPB found that borrowers who don’t have any existing debt stand to gain the most from a credit builder loan.
Borrowers without any existing debt saw their credit score increase by 60 points more than participants who already had debt. On the other hand, some participants with existing debt saw their credit scores while paying off a credit builder loan.
Based on the information in the study, it appears that a credit builder loan is best positioned to help those without existing debt. But you won’t be able to reap the rewards if you are unable to make on-time payments.
If you decide a credit builder loan is right for you, then it’s time to find the right fit!
Here’s a step-by-step look at how to obtain a credit builder loan.
Before you sign on the dotted line for any credit builder loan, make sure to read the fine print. You don’t want to get stuck with a monthly payment you can’t afford. If you have questions about a loan, don’t be afraid to ask questions of the lender before committing.
A credit builder loan isn’t the right fit for everyone. Luckily, it’s not the only way to build credit.
Here are some other strategies that can help you improve your credit score
If you make on-time bill payments, you can turn that into a credit-building opportunity with Experian Boost. A few of the alternative payments you could get credit for include streaming services, utility bills, and cellphone plans. The service adds on-time bill payments to your credit report.
It’s easy to sign up and turn your responsible habits of paying bills on time into credit. According to their site, average users saw their FICO score increase by 13 points.
Payment history represents 35% of your FICO score. If you are making on-time payments to your current debts, that can have a positive impact on your credit score.
If possible, make on-time payments a priority. One way to avoid a missed payment is to set up automatic payments. An assist from technology means you won’t forget about a payment ever again.
Credit cards are a type of revolving debt that will impact your credit utilization rate. This factor accounts for 30% of your FICO score.
Most experts recommend keeping your credit utilization rate lower than 30%. So, if you have a high credit utilization ratio, work on paying off your credit cards.
As an authorized user, someone will add you to their credit card account. Although you won’t be the primary account holder, the activity is reported to your credit report.
If the account holder is making on-time payments and keeping a low credit utilization rate, that information will be a positive addition to your credit report.
A secured credit card is a type of credit card that requires a security deposit. Typically, the size of your line of credit is tied to the amount you commit to as a deposit.
This product can help your credit score if you make on-time payments. But the relatively low limits make it easy to rack up a high credit utilization rate.
A credit builder loan offers the chance to help you build a history of on-time payments. In theory that should give your credit score a boost. But you’ll need to decide for yourself if the costs of a credit builder loan are worth the potential rewards.
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