What is a Credit Builder Loan?
A credit builder loan is offered by banks, credit unions, or specialized financial institutions in the United States with the specific purpose of helping individuals to establish or improve their credit score. It functions as a tool that allows individuals to establish a credit history or rebuild and improve an existing poor credit rating, which can lead to better access to credit in the future.
Credit builder loans work differently from other traditional loan offers. First, the lender holds the borrowed amount in a secure account such as a certificate of deposit (CD) or savings account. The borrower then makes fixed monthly payments, which are reported to the credit bureaus as a positive payment history. After the borrower has successfully repaid the loan, the money they borrowed is released to them, and they have improved their credit score.
There are two types of credit builder loans: secured and unsecured. A secured credit builder loan requires an asset as collateral, such as a savings account, whereas an unsecured credit builder loan does not require collateral but may have higher interest rates.
Credit builder loans offer borrowers an opportunity to establish or rebuild their credit history in a structured way and enable them to improve their credit scores over time. Credit builder loans can also help individuals achieve their financial goals, like purchasing a home or car.
Features
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Establish or improve credit history. Unlike traditional loans, credit builder loans are not intended to provide immediate funds to the borrower. Rather, the loan is structured so that the borrower makes regular payments over time, which are reported to the credit bureaus. These payments are used to establish a positive payment history, which is a key factor in determining one's credit score.
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Secured loans. Unlike traditional loans that require collateral (such as a house or car), credit builder loans are typically secured by a savings account. The borrower must make regular payments towards the loan, which are then deposited into the savings account until the loan is paid off. At that time, the borrower can access the funds in the savings account.
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Interest rates. This is because the loans are typically smaller and are designed to be paid back over a shorter period of time. Additionally, because the loans are secured by a savings account, there is less risk for the lender.
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Accessible to almost anyone. Because credit builder loans do not require a credit check, they are a great option for people who have bad credit or who are new to credit.
Pros and cons
- Helps build credit. Credit builder loans are designed to help build credit scores. On-time payments are reported to the credit bureau, thus increasing your credit rating.
- Lower interest rates. Credit builder loans have lower interest rates compared to other types of loans. So, they can help individuals save some money on interest payments.
- Helps in financial planning. With a credit builder loan, borrowers are required to make regular monthly payments, which helps them in financial budgeting and planning.
- High fees. Credit builder loans can sometimes come with high fees. Some lenders charge fees for origination, processing, and administration.
- Limited loan amount. Most credit builder loans come with a relatively low loan amount. This means that borrowers may not have access to sufficient funds to meet their financial needs.
- Slow process. Credit builder loans can sometimes take longer to process and approve compared to other types of loans. This can be a disadvantage for people who need funds urgently.
- Risk of default. If borrowers fail to make timely payments, they may end up defaulting on the loan. This can negatively impact their credit score and make it even more difficult to get credit in the future.
How to get a Credit Builder Loan?
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Know your credit score. Before you apply for a credit builder loan, you need to know your credit score. This will help you understand what type of loan you may qualify for and what interest rates you may receive. You can access your credit score for free once a year.
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Research lenders. There are several mainstream banks and credit unions offering credit builder loans in the US. You can also find alternative lenders online who specialize in these types of loans. Be sure to read reviews and compare interest rates and fees before applying.
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Decide on the loan amount. Credit builder loans are typically small loans, usually between $300-$1,000. The amount you borrow should be manageable for you to repay and will vary based on your lender's requirements.
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Apply for the loan. Once you've chosen a lender, you can start the application process. To apply, you will need to provide personal information, such as your name, address, and social security number. You may also be required to provide your income information or employment status.
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Make payments on time. Once you receive the funds from the loan, you must make timely payments on the loan to establish credit. The lender will report your payments to the credit bureaus, which will help improve your credit score.
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Monitor your credit score. You need to monitor your credit score regularly to track your progress. Most lenders offer online access to your payment history to help you keep an eye on your score.
Best places to borrow a loan with bad credit
Upgrade
Upgrade is a prominent online lender that offers personal loans to borrowers with bad credit. They provide loan amounts ranging from $1,000 to $50,000, making them suitable for various financial needs. The minimum credit score required by Upgrade is relatively low, typically around 580. This makes it accessible to individuals with a less-than-stellar credit history. One notable advantage of Upgrade is its flexible repayment terms, which can extend up to five years. This longer repayment period allows borrowers to manage their monthly payments more effectively. However, it's worth noting that Upgrade charges origination fees ranging from 2.9% to 8%. Additionally, while they do not have any prepayment penalties, borrowers should be aware of the interest rates, which can be relatively high for individuals with bad credit.
Upstart
Upstart is another online lender that specializes in providing loans to borrowers with bad credit. Their loan amounts range from $1,000 to $50,000, allowing borrowers to access the funds they need for various purposes. Upstart utilizes a unique underwriting model that takes into account factors beyond just credit scores, making it more inclusive for individuals with limited credit history or low credit scores. The minimum credit score required by Upstart is typically around 580. One of the significant advantages of Upstart is its soft credit check, which means that applying for a loan does not negatively impact your credit score. Repayment terms offered by Upstart range from three to five years, providing borrowers with flexibility. While they do charge origination fees of up to 8%, it's important to note that they don't impose any prepayment penalties. However, borrowers with bad credit should expect higher interest rates.
LendingPoint
LendingPoint is a bad credit lender that offers personal loans ranging from $2,000 to $36,500. They consider borrowers with credit scores as low as 585, making them accessible to individuals with bad credit. LendingPoint prides itself on providing fast funding, often disbursing funds within one business day. Their repayment terms typically range from two to four years, allowing borrowers to tailor their loan duration according to their needs. It's important to note that LendingPoint does charge origination fees that can be up to 6%. They also have a slightly higher interest rate compared to traditional lenders, which is to be expected when borrowing with bad credit. However, they do not impose any prepayment penalties, enabling borrowers to pay off their loans early if they desire.
Universal Credit
Universal Credit is an online lender that specializes in bad credit loans, offering loan amounts ranging from $500 to $15,000. Their minimum credit score requirement is relatively low, typically around 550, making them accessible to borrowers with poor credit. Universal Credit offers repayment terms ranging from six months to five years, allowing borrowers to choose a duration that aligns with their financial situation. While they charge origination fees, the amount may vary based on the borrower's creditworthiness. One notable advantage of Universal Credit is its willingness to consider applicants who have previously filed for bankruptcy. However, borrowers should be aware that the interest rates associated with bad credit loans from Universal Credit may be higher compared to traditional lenders.
OneMain Financial
OneMain Financial is a well-established lender that specializes in bad credit loans. They offer loan amounts ranging from $1,500 to $20,000, making them suitable for various financial needs. OneMain Financial requires a minimum credit score of 600, slightly higher than some of the other lenders in this category. However, they have a reputation for considering other factors beyond credit scores when evaluating loan applications. OneMain Financial provides repayment terms that range from two to five years, allowing borrowers to select a term that fits their budget. It's important to note that OneMain Financial charges origination fees, which can vary depending on your residence state. While they do not disclose their interest rates upfront, borrowers with bad credit should expect higher rates.
Avant
Avant is an online lender that specializes in offering personal loans to individuals with bad credit. They provide loan amounts ranging from $2,000 to $35,000, catering to various financial needs. Avant has a minimum credit score requirement of 580, making them accessible to borrowers with less-than-ideal credit histories. Repayment terms offered by Avant typically range from two to five years, giving borrowers flexibility in managing their monthly payments. While Avant charges origination fees up to 4.75%, they do not impose any prepayment penalties. It's important to note that Avant's interest rates can be relatively high for borrowers with bad credit. However, they provide a transparent prequalification process that allows borrowers to check their potential loan offers without affecting their credit scores.
Requirements and conditions
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Minimum age. The applicant must be at least 18 years old to be considered for a credit builder loan.
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Income requirement. Most lenders will require the applicant to have a steady source of income to ensure they have the ability to repay the loan. This could be through employment, self-employment, or other sources such as rental income.
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Credit check. While credit builder loans are typically offered to people with poor or no credit history, some lenders may still require a credit check to determine if there are any outstanding debts or late payments.
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Collateral. Some lenders may ask for collateral to secure the loan, such as a car or savings account. This helps to mitigate the risk of lending to someone with poor or no credit history.
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Residency. The applicant must be a legal resident of the US to qualify for a credit builder loan.
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Bank account. Most lenders require the applicant to have a bank account in good standing to ensure that loan payments can be processed and to verify their financial stability.
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Employment history. While not always a requirement, some lenders may look at the applicant's employment history to determine their ability to repay the loan and their overall financial stability.
Ways to get the money
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In person. Many community banks and credit unions offer credit builder loans, and you can typically apply for the loan in person at the bank or credit union. You will need to provide some basic financial information, including your income and employment status. If you are approved for a loan, you may be able to receive the funds in person, either in the form of a check or cash.
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Direct deposit. Some lenders offer credit builder loans that are funded through direct deposit. This means that the loan amount will be transferred directly to your bank account, and you can use the funds to make payments on the loan or pay off other debts. Direct deposit loans can be a convenient option because you can access the funds quickly and easily.
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Debit card. Some lenders may offer a debit card option for receiving the money from a credit builder loan. This means that the funds will be loaded onto a prepaid debit card that you can use like a regular debit card. This can be a convenient option if you don't have a bank account or if you prefer to use a prepaid debit card for your finances.
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Check. Some lenders may also offer the option of receiving a check for the funds from a credit builder loan. This means that the lender will send you a check for the amount of the loan, which you can then deposit into your bank account or cash at a bank or check-cashing location.
Things to pay attention to
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Do your research. There are various lenders that offer credit builder loans, so do your research and compare the interest rates, fees, and terms of each lender. Look for a lender that reports to all three credit bureaus, as this will help you establish a positive credit history across all the credit bureaus.
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Understand the fees. Credit builder loans often come with fees, such as origination fees, maintenance fees, and prepayment penalties. Make sure you understand all the fees associated with the loan before you sign the agreement.
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Make payments on time. Timely payments are key to building credit with a credit builder loan. Late payments or defaulting on the loan can negatively impact your credit score and defeat the purpose of the loan.
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Plan ahead. Make sure you can afford the loan payments before taking out a credit builder loan. Late payments or defaulting on the loan can cause damage to your credit score and make it harder to obtain credit in the future.
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Set a budget. Since credit builder loans require monthly payments, it is important to plan your budget accordingly. If the loan payment is too high, you may need to adjust your budget to ensure timely payments.
How to repay a Credit Builder Loan?
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Understand the terms and conditions. This includes the amount of the loan, the interest rate, and the repayment schedule.
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Set up automatic payments. One of the best ways to make sure that you don't miss any payments is to set up automatic payments. This can usually be done through your bank or through the lender. Ensure there is enough money in your bank account to make the payments.
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Make more than the minimum payment. While making the minimum payments on a credit builder loan will help you build your credit history, it is ultimately better to pay more than the minimum amount due each month. This will help you pay off the loan faster and will save you money on interest charges.
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Monitor your credit report. It is important to monitor your credit report regularly to ensure that the payments are being reported accurately. If you notice an error or a discrepancy, you should contact the credit bureaus to have it corrected.
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Make sure that the loan is paid off in full. Once the loan is paid off, the money that was deposited into the savings account will be released to you. This can be used to pay down other debts, build an emergency fund, or for any other purpose.
Alternatives
Credit builder loans are a popular way for individuals to build their credit history, but they are not the only option available in the US. In fact, there are several alternatives that individuals can explore to boost their credit score and establish a good credit history.
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Secured credit cards. A secured credit card is an excellent way to start building credit, especially if you have a limited credit history or have been denied credit in the past. With a secured credit card, you typically deposit a certain amount of money, which serves as your credit limit. The secured credit card issuer reports your on-time payments to the credit bureaus, helping you establish a good credit history.
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Co-signed loans. If you have a friend or family member with good credit, you may be able to co-sign on a loan to help build your credit history. When you co-sign a loan, you are responsible for making payments if the primary borrower fails to do so. Co-signed loans are typically easier to obtain than unsecured loans, and the on-time payments will show up on your credit report.
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Becoming an authorized user on a credit card. If you have a trusted family member or friend with excellent credit, you could ask them to add you as an authorized user on their credit card. As an authorized user, you will be able to make purchases on the card, and the account holder's payment history will appear on your credit report.
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Rent reporting services. Rent reporting services, such as Rental Kharma or RentTrack, can help you establish a credit history by including rent payments on your credit report. This option is excellent for individuals who don't want to take out a loan or a credit card to build credit.
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Credit counseling. If you're struggling with bad credit, consider working with a credit counseling agency. They can help you come up with a debt management plan to pay off your outstanding debts and help you prioritize which debts to pay off first.
Editorial opinion
Credit builder loans can be a useful tool for people who are trying to improve their credit scores and build their credit histories. However, they can be expensive. Many credit builder loans come with high interest rates and fees. In some cases, the cost of the loan can outweigh the benefits of improving your credit score. If you cannot make ends meet, it can be difficult to commit to regular loan payments. Missing payments can have a negative impact on your credit score. The decision to take out a credit builder loan is a personal one that should be made based on your individual financial situation and goals. If you are struggling with debt or other financial issues, it may be worth consulting with a financial advisor or credit counselor to explore your options and make a plan for improving your financial health.
Important
How to Choose a Lender
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Make sure to confirm whether the lender is licensed to operate in your state. You can verify this information with your state regulator or attorney general.
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Check if the lender is a member of a reputable association, such as the Community Financial Services Association of America. Membership in such organizations may provide an extra level of reliability.
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Carefully review all the terms and conditions of your payday loan contract.
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Thoroughly examine the interest rates on payday loans and ensure that your contract includes a detailed breakdown of the total cost of the loan.
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Take advantage of your right of rescission. Usually, you can rescind the loan within three days after signing the agreement. Alternatively, there is typically a "cooling-off" period, which allows you several days to thoroughly review the contract before making an informed decision to enter into a consumer loan agreement based on the terms specified by the lender.
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Choosing a payday lender is a significant decision that demands careful consideration and a good understanding of how such organizations operate.
Additional Resources
- What Credit Score Do You Need for a Personal Loan?
- How to Get a Personal Loan in 7 Steps
- Personal Loan Pre-Approval
- How to Apply for a Personal Loan
- Personal Loan vs Personal Line of Credit
Sources
- Equifax. What Is a Credit-Builder Loan? 26.09.2023
- Nerdwallet. What Is a Credit-Builder Loan? 26.09.2023
- Credit Karma. Credit-builder loans: What they are and how they work 26.09.2023
- Forbes. What Is A Credit-Builder Loan? 26.09.2023