Posted by Jim McClaflin, EA, NTPI Fellow

Understanding Credit Builder Loan & How it Works

Understanding Credit Builder Loan & How it Works

Since lending is a risky endeavor, lenders are usually interested in lending money to people with good credit history. It is not surprising as good credit implies that someone will likely pay back the loan. However, there is no way to build credit unless you get the chance to prove your capability. When you think about it with the mindset of a lender, it makes sense as no one wants to risk someone whose riskiness is unknown. 

However, it can be frustrating if you want to borrow and no one seems keen on giving you a chance. The good news is there are ways lenders can offer you a loan and avoid the risk of the borrower not paying back. The credit builder loan is one such way. 

If you want to raise your credit, credit builder loans can help, provided you do it the right way. 

A credit builder loan means you only get access to a sum of money you want to borrow until you make the full payment. Since they are in control of the funds, and there is no risk, lenders offering credit builder loans are usually keen on giving them to borrowers with poor or zero credit. After getting such loans, the lender will report your payment history to all the credit reporting agencies. With this, building credit will be possible.

 

How a Credit Builder Loan Works 

Typically, small financial institutions like credit unions and community banks offer credit builder loans.

Any amount you agree to borrow will be deposited in a bank account controlled by the lender on getting such a loan. You will have to make monthly payments (principal and interests) reported to the credit bureaus for a fixed term. When you pay off the loan, you get the funds from the account. 

The ability of a credit builder loan to improve your credit depends on you. 

Such a report on your loan payment will go to the credit bureau. Timely repayment of your credit will help build positive credit history. This will be responsible for 35% of your FICO credit scores. Late payment will also be reported, which you don’t want. Someone without a credit history who makes a late payment will have a huge setback.

 

How to Get a Credit-Builder Loan 

Here are various things you will need for a credit builder loan:

  • Get a financial institution offering such: You can get this from local banks, credit unions, online lenders, etc. Ensure the lender will report your payments to the three consumer credit bureaus

  • Decide the amount to borrow: Typically, the loan amount ranges from $300 to $1000

  • Compare various lenders: there could be variations in terms of interest charged, monthly payment plan, origination costs and others. 

  • Apply for the loan: Basic information like your name and address are necessary. However, absence of credit will not disqualify you.

After approval and the loan is granted, you will make total payments until you repay the loan in full. When you do this, you will get the entire funds.

 

Cost of Credit Builder Loan

There is no fixed cost as it depends on the lender. Here are essential things to pay attention to when applying:

  • The APR: Also known as the annual percentage range, this is the funds your lender charges you to borrow the funds. Most lenders have an APR below 10%, even though some lenders might be higher. 

  • Interest: Lenders, in this case, might withhold some of your entire interest payment and offer you just the balance when the loan term ends. 

  • Extra Fees: There might be an application fee or a late payment charge 

  • Loan Repayment term: You will be charged with more interest if your loan has a longer-term

  • Minimum and maximum loan limit: Ensure you don't borrow excessively much or too little. Borrowing too much will take a long time to pay, which will also mean more interest. 

When you get a lender whose terms are favorable, it will be easy to use such services to boost your credit without breaking the bank.


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Jim McClaflin, EA, NTPI Fellow
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