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Credit-Builder Loans: What They Are & How They Work?

What is a Credit-Builder Loan
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When people research ways to build or improve their credit, they may hear the term “credit-builder loan.” But how can a loan help build someone’s credit and why would people use these loans to build their credit?

A credit-builder loan is a sum of cash held in an account by a lender while a borrower makes monthly payments against the loan. The on-time payments made during the loan period enhance the borrower’s payment history and, consequently, their credit. 

The rest of this article will provide essential aspects to consider about credit-building loans and where you can go to secure one for yourself. Let’s get started so you can see how easy it is to build your credit quickly.

Considerations Related to Credit-Building Loans

Like any financial investment or program, people should make every effort to understand both the benefits and the requirements of credit-building loans. 

What are the most important considerations?

The most important aspects to consider in a credit-building loan are the ideal borrower type, interest rate, and total monthly payment. Once the loan term ends, the lender releases the loan amount to the borrower.

Let’s dig into each of these considerations so you can determine whether this credit-building vehicle is appropriate for you and your needs.

Ideal Borrower Type

Credit-builder loans are not for everyone. 

The ideal borrower is someone who has no or little credit or a person who wants to improve their credit score significantly. The borrower’s goal is not to acquire a sum of money upfront. 

Instead, the borrower hopes to “pay to play” and, ideally, increase their credit score through making regular payments. 

Credit-building loans may help you qualify for large sums of credit eventually. However, if you have decent credit or are looking for a way to borrow a sum of money in the short term, a credit-builder loan is likely not the right fit for you.

Interest Rate

The majority of lenders offering a credit-building loan charge an interest rate. Although this type of loan is not a big moneymaker for these institutions due to the generally low loan amount, they make some revenue for their effort. 

When shopping between various institutions, ensure you ask what the interest rate is associated with the loan. The annual percentage rate (APR) may vary between 6% and 16% or more, which is a wide range. 

Comparison shop and, if you have multiple lenders who are willing to work with you, choose the one with the lowest rate. Before making a final decision, you need to be confident that you can cover the total monthly payment, regardless of the interest rate.

Total Monthly Payment

Once you sign, your lender will expect a fixed monthly payment from you. Before moving forward, verify that the price your lender quoted you includes the principal payment, interest, and any/ all fees. 

Once you have a firm monthly payment amount, check and double-check that you have enough income each month to cover the full payment for the entire loan period.

If you miss payments on your loan, you run the risk of lowering your credit score instead of raising it!  Now that you know what to consider related to credit-builder loans, you may be wondering who to reach out to get one and build your credit.

Where to Get a Credit-Builder Loan

Unfortunately, not every lender will offer credit-builder loans. Reach out to the following types of institutions to determine what they have to offer:

Nonprofits

Some nonprofits offer programs to help people build their credit. Some even do so without an interest payment. For example, the Local Initiative Support Corporation (LISC) provides a $300 loan requiring payments of $26.24/ month for 12 months. 

LISC sweetens the deal by offering a 100% match for every on-time payment you make. 

Assuming on-time payments, you will have $600. When you contribute $300 for the month, LISC will contribute $300 on your behalf. Additionally, your 12 months of positive payments will increase your credit score.

Community Banks

If you have a savings or checking account, reach out to your local bank and ask about their available programs. 

As you already have a relationship established, this may be a quick source. If your bank does not have a suitable program or is otherwise unable to help, ask them for a referral to another local or online institution.

If you do not already have a bank account, do a quick online search for banks in your hometown. Pick up the phone and start dialing!

Credit Unions

Credit Unions often tout their desire to build a close relationship with customers and often offer these types of loans and other credit-building programs within the community. 

If you are not currently a member of a credit union, see whether there are any nearby.  If so, identify their general membership requirements and determine what types of programs they offer.

Credit unions often work with people who have less than stellar credit. Check out this U.S. News and World Report article outlining eight of the top credit unions that may offer an excellent place to begin your search.

Online Lenders

There are numerous online lenders, such as Self, Fig, Credit Strong, and more that offer various loan types, including credit-builder loans. 

These online options increase access to unique programs for folks with limited in-person lending options. Before choosing to work with an online vendor, ensure you do your due diligence on the lender’s reputation through the Better Business Bureau and other review sources.

To ensure the most significant impact on your score, confirm that your chosen lender will report your payment status to all three credit reporting agencies (Experian, Equifax, and TransUnion). 

Should I Get A Credit-Builder Loan?

Credit-builder loans help borrowers improve their credit. On-time payments to reputable lenders lead to positive reports to the various national credit bureaus. 

If you are interested in determining whether one of these loan programs is suitable for you, identify local or online institutions that offer programs. Do your research to ensure you know the interest rate and all relevant repayment terms!


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