What is a Credit Builder Loan?

How does credit builder loans work? Is it useful for building a credit?
Expert answer by Alex Gerard,
10+ years experience in banking consulting

A personal loan can be a great help in building a person’s credit history.  One of the important parts of the credit score equation is the mix of the credits you have. If your credit score is in low digits, consider getting a secured “credit builder” type of personal loan – combined with a credit card it can help you in establishing a credit and growing your score in one year.

Who might need that type of loan?

Credit builder loans are for people rebuilding their bad credit histories. IF you are after bankruptcy or just bad credit, you are looking for ways to faster rebuild your credit ratings and recover. Getting a secured card can be a great first step, but adding a credit builder loan to the mix is a perfect option.

How does it work?

Credit builder loans are very similar to secured cards, with only one big difference - a secured card is useful for electronic payments and everyday use when a credit builder loan is something that you use solely for credit rebuilding purposes. Some banks claim that it helps you to boost your savings, but it is not necessarily true.

So when you sign up for such loan, the bank extends you a small loan but keeps all the money on the savings-like account in the same bank. Basically, bank gives you a loan of several hundred dollars but then keeps the whole amount.

Then you repay the loan every month with the interest to the bank. 

After a loan period of usually one year, your loan is paid off and the bank releases any additional money that was accumulated on your account through your payments (if any).

Your biggest gain from the process is that the bank reports your payments to the credit bureaus thus building your credit history.

What are the benefits?

Some of the biggest benefits are:

  • You build your credit history by repayment your loan
  • A loan is a different type of credit than a credit card (an installment credit vs revolving credit) - it helps to boost the "credit mix" part of your credit score.

 

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