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Credit enhancement loans can help you build or repair your credit, even if you don’t qualify for a traditional personal loan. (Shutterstock)
A credit-building loan is a financial product used – as the name suggests – to help someone establish or develop credit.
Unlike traditional personal loans, credit enhancement loans are not necessarily designed for people who need to borrow money for a large or unexpected expense. On the contrary, they make it easier for borrowers to repair their existing credit while building savings.
Here’s how credit building loans work, how to get one, and some alternatives to consider if you’re trying to build credit.
If you are considering a traditional personal loan, Credible allows you to view your prequalified personal loan rates from various lenders, all in one place.
What is a credit builder loan?
With a standard personal loan, a lender gives you money up front, which you repay in a series of installments until the debt is satisfied.
With a credit loan, however, the lender does not disburse any initial funds. Instead, the lender will hold the money in a designated account (where it may or may not accrue interest) until you repay the loan amount.
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How does a credit builder loan work?
A credit builder loan works in the reverse order to a traditional loan:
- After getting approved for a credit builder loan, your lender will deposit the money you want to borrow from a bank account that he holds. The lender does not pay you this money.
- You will then make monthly payments on the loan as expected, as for a personal loan, generally over 6 to 24 months. The difference, of course, is that you’re making monthly payments on money you don’t actually have on hand and can’t touch yet.
- As you make your payments each month, your lender will report your payments to the credit bureaus. They can choose to report to one, two or all three agencies, including Equifax, Experian and TransUnion.
- Making payments on time will help establish your credit history (if you have little or no credit) or increase your existing score.
These reported payments will help build the payment history portion of your credit report, as well as increase the average age of your accounts and your credit mix, all of which can improve your credit score overtime.
Once you have repaid the loan, the lender will return the money that was held in your credit account. You can then use this money as an emergency savings account, to pay off credit cards, or to cover large or unexpected expenses.
Credible does not offer credit loans. But you can visit Credible for compare personal loan rates from various lenders, without affecting your credit score.
How to get a credit builder loan
If you want to apply for a credit loan, follow these four steps:
- Find a lender that offers credit loans. Compare credit loans from at least a few different lenders. Look at the loan amounts they offer, interest rates and repayment terms. This will allow you to find the most profitable loan for your needs.
- Make sure you meet the eligibility criteria. It is generally easier to qualify for a builder’s credit loan than to take out a standard personal loan, because the lender takes on less risk by retaining the amount borrowed. But you may still need to meet certain requirements related to your age, income, citizenship, and place of residence. If the loan is offered by a credit union, you may also need to become a member to take out a loan.
- Apply for the loan. Once you’ve found a competitive loan product that meets your needs, it’s time to apply. You may need to provide additional documents to verify your identity and income.
- Start making payments. Once your loan is finalized, you will begin making payments to your lender as agreed. At the end of the loan repayment term, you will receive the funds.
How much does a credit builder loan cost?
The cost of a credit loan comes down to interest and time.
These loans – like personal, car, and student loans – come with an interest rate. This is the lender’s fee for lending you that money, expressed as a percentage. Credit enhancement loans are less risky for lenders than immediate disbursement loans, so they often come with lower interest rates. This can save you money over the life of the loan.
For some borrowers, however, time may be the biggest cost. Since credit-building loans are not disbursed until the debt is satisfied, you will be paying off the balance of a loan that you have not actually received. If you need the money to consolidate other debts, pay a big expense, or build emergency savings, you’ll have to wait up to 24 months to access that money.
Alternatives to credit-generating loans
Like all credit products, credit-generating loans have both advantages and disadvantages. Whether you’re trying to build up a non-existent credit history or recover from a 500 credit pointsthese loans can help, but they are not necessarily suitable for everyone.
If you are looking to create credit but are not sure that a credit-generating loan meets your needs, here are some alternatives to consider:
- Secured personal loan — These loans offer an upfront disbursement of funds, but you will provide a collateral asset to secure the debt, such as your car title or home equity. This security reduces the lender’s risk and can make it easier for borrowers with little or no credit to qualify. But if you are behind on your loan repayments, the lender can take your collateral.
- Secured credit card — These lower limit credit cards allow you to establish your credit history. You’ll pay a deposit to get the card, and your credit limit is usually the same as your deposit amount. But if you make payments on time for a certain period, you may be able to convert your secure card account into a traditional credit card product.
- Become an authorized user on a credit card — A parent, spouse, sibling or friend with good credit can add you to their existing credit card account as an authorized user. In many cases, their own account activity will then be credited to you, helping you build or repair your credit score without having to spend any money.
If you’re interested in a secured personal loan or applying for a loan with a co-signer, Credible makes it quick and easy compare personal loan rates to find the one that suits your needs.
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