Just like its name implies, a credit builder loan can help you boost a low FICO score. It is a small loan and the terms will vary depending on the financial institution. It also doesn’t require a good credit score for approval.
You might be wondering why you haven’t heard of a credit builder loan before. This is due to the fact it is rarely advertised, and typically only offered at community banks and credit unions.
Types of Credit Builder Loans
There are different types of credit builder loans and each can come with additional financial benefits. If you apply for an unsecured credit builder loan, the money is provided upfront. This is a good option if you need cash for an emergency expense.
A loan secured by funds will help you learn how to save money. The amount of the loan is held, until you have paid it off. If you only want to improve your credit portfolio, and don’t need money immediately, this can help you become more financially responsible.
You can also apply for a secured loan, and if you need to quickly raise your FICO score it might be a financially sound option. You will need to have the amount you are borrowing in your account, where it will be frozen until you have repaid the loan in its entirety.
How Credit Builder Loans Work
Credit-building loans typically range from $100 to $1500, rarely any higher since one of the terms is usually that it needs to be repaid in 12 months or less.
Most financial institutions also require that the applicant is financially stable. Common requirements include,
- Member of the institution
- Proof of employment
- In good standing with the bank
If you meet all the requirements you’re chances of approval are good, regardless of your credit score.
One of the main disadvantages is the typically high interest rate that can make it difficult for some borrowers to make their payments on time. For example, if you have a bad or no credit score your interest rate could be 18.99 percent or higher.
Fico Scores and Credit Building Loans
According to one of the directors at Credit Builders Alliance, Sarah Chenven, the majority of consumers that apply for one of these loans are working towards a larger financial goal.
A study conducted in 2013, found that credit scores could improve up to 35 points in 6 months by paying off a small credit building loan. This can make it easier for you to get approval for an auto loan, mortgage or even an unsecured credit card.
If you have missed or late payments from other accounts the boost to your credit score will be lower, usually around 20 to 25 points. This can still be enough to raise a poor FICO score to “fair”.
Get The “Most” Out of a Credit Builder Loan
If you believe that a credit-building loan is financially right for you, there are a few steps you can take to ensure that you get all the possible advantages.
- Are you financially ready? If you’re having problems paying your existing bills on time, you will want to wait to apply for a credit-building loan. It will cause more damage to your credit score if you can’t make the payments, and any money that you have in your accounts could be forfeit.
- Shop around. There are different types of loans with varying terms and benefits. Along with checking with your local credit union, see what other financial institutions are offering. Some credit builder loans are designed for specific borrowers, and one of these might fit your unique financial situation.
- Understand the terms. This is important. If you don’t understand all the loan requirements, it can cause problems later on. Don’t be afraid to ask the lender any questions. This can include,
- Collateral, if applicable
- Interest rate
- Payment due date
- Never make a late payment. Any late payments will be reported to the credit agencies, and this will hurt your FICO score. It can also be difficult to get back on track, especially if the high interest rates are piling up.
- Don’t double up payments. It can be tempting to shorten the length of the loan by paying it off faster. While it can be less stressful, it won’t help your credit score. You need every payment to count, if you want your FICO score to increase. The purpose of this type of loan is to build your credit and that takes time.
Building Good Credit Takes Time
While you can ruin your credit in a relatively short amount of time, it takes longer to rebuild it and this type of loan can give it a little push up.
Just remember to “shop around” and understand the loan terms. It is also important to make every payment on time, even if the funds are being held in your account. If you follow every guideline, you should see your credit portfolio improve during the life of the loan.