A credit-builder loan works like a normal loan but in reverse. With a credit-builder loan, the lender puts money into a savings account for you, you make fixed monthly payments totaling the amount in the account plus interest, and then you get the money in the account once you make all the payments. You can see the full step-by-step process of how a credit-builder loan works below.
How a Credit-Builder Loan Works
The lender opens a savings account. After the lender approves your application, they set aside a about $300 - $1,000 in a savings account for you. But you won’t have access to the money until you pay off the loan, plus interest.
You make payments. You will make equal monthly installment payments to the lender over 6 to 24 months, depending on the size of the loan and the lender’s policies.
The lender reports your payments to the credit bureaus. The lender will report your payment status, whether on-time or late, to the credit bureaus each month. If you pay on time, your score should increase. If not, your score will decrease, which defeats the purpose of getting a credit-builder loan.
The lender charges interest. APRs tend to range between 6% and 16%. The cost of this APR may be slightly reduced by the interest you earn on the savings account, if the lender puts your money in an interest-bearing account. In addition, the lender may return some of the interest you pay on the loan at the end.
You receive the funds. The lender will give you the money in the account once the loan term ends. You will be free to use the funds for whatever you wish.
Yes, a credit-builder loan is a good idea because it’s an easy, low-risk way to establish or rebuild your credit history, especially if you don’t want to get a credit card for one reason or another. With a credit-builder loan, the lender will put money into a savings account for you and you’ll make payments to them over a set time. These payments will add up to the amount of money the lender put in the savings account, plus interest. You’ll get the money in the savings account at the end of the loan term once you make all the payments. … read full answer
Reasons Why a Credit-Builder Loan is a Good Idea
Your money may be put in an interest-bearing account.
You may get a portion of your interest payments back.
If you’re establishing credit from scratch, you may have a score of 630 - 650 by the end of the loan term.
The APR range on a credit-builder loan is lower than on a conventional loan or credit card.
The lender gives you the money in the savings account in a lump sum at the end of the loan term if you make all your payments.
Just because a credit-builder loan is a good way to improve your credit score does not mean it is the best, though. The best approach is to use a credit card, perhaps supplemented by a credit-builder loan, because the issuer will report positive information to the credit bureaus whether you pay the bill on time each month or leave your card with a $0 balance.
A credit-builder loan can hurt your credit score because some lenders perform a hard inquiry into your credit history when you apply, which can drop your score by about 5 to 10 points. Lenders will also report negative information to credit bureaus if you miss a credit-builder loan payment or make a late payment.… read full answer
However, if you make your monthly payments on time, the lender will report positive information to the credit bureaus, which improves your score. For example, if you're establishing credit from scratch with a credit-builder loan, you should expect to have a score around 630 - 650 by the end of your loan term.
To see how a credit-builder loan may affect your credit, check out the free credit score simulator on WalletHub.
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