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your Credit score is one of the main factors that helps you qualify for credit and set your interest rate. If that number falls below the benchmark for good credit, you could be stuck with a high interest rate and expensive monthly payments.
One way to address this issue is to take out a credit builder loan. This loan is designed specifically for borrowers who want to improve their score. However, it comes with the same risks as any other type of loan. Consider the pros and cons before applying.
Benefits of a Credit Builder Loan
A credit builder loan is a way to show the major credit bureaus that you can always make payments on time, which can make it easier for you to access other financial products in the future.
You can improve your credit
Most notably, a credit builder loan will improve your credit score. When you make your payments on time each month, those payments are reported to the credit bureaus. Your payment history can account for up to 35 percent of your score, so improving that track record can improve your credit score.
Flexible Acceptance
Because credit builder loans are designed for people with low credit scores and little or no credit history, lenders have more flexible borrowing qualification requirements. Lenders don’t require good credit, but instead may ask for information about your income, employment history, and savings and checking account balances. Even with looser qualification requirements, lenders still want to see that you can repay the loan.
Ability to accumulate savings
Typically, taking out a loan means borrowing money to cover a large expense. In this case, the lender holds onto the money and sends it to you, minus a fee, once you pay it back. So you’re saving money for later. Some lenders also let you put your money in a savings account to earn interest, but it might not be enough to offset the annual percentage rate the lender charges.
Disadvantages of Credit Builder Loans
Although credit builder loans have their advantages, borrowing also comes with risks.
Your credit score may drop
Like any other loan, missing payments on a credit builder loan can lower your credit score. Missing payments on a credit builder loan can significantly lower your score and put you in a more difficult financial situation.
Lenders can charge high fees
Interest rates and standard fees vary widely between lenders. Some offer zero interest or fees, while others will refund a portion of the interest when you pay off the loan. Others charge hefty fees that can significantly increase your expected monthly or total costs. Common fees include prepayment penalties, issuance or administrative fees, and processing fees.
Money is not readily available
Credit builder loans often have repayment terms of up to 24 months, and you won’t be allowed to take out the loan until it’s paid off. This loan isn’t suitable for people who need cash quickly, as you must repay the loan in full to receive the cash.
If you need cash quickly in an emergency, consider an emergency loan.
Are Credit Builder Loans Worth It?
Ideal candidates for credit builder loans are individuals with no credit history at all. It can be difficult to purchase financial products without a history, but these loans can help you build your credit history.
Meanwhile, borrowers who already have debt may be able to find lower-cost, more efficient options for boosting their credit scores.
A credit builder loan may not be the best option for borrowers on a tight budget. Rather than taking on new debt, consider self-declaring your rent or getting a secured credit card for everyday purchases.
Conclusion
Taking out a credit builder loan can be a great option for some borrowers, but it’s not ideal for everyone. While it’s an option for those without a great history, this type of loan may not provide you with funds quickly and may have higher fees.
If improving your score is a priority and you’re confident in your ability to repay a loan, a credit builder loan can be the first step to achieving excellent credit. Be sure to research the options available to you before diving into any financial commitment.
