How to Use a Credit Builder Loan to Build Your Credit Score?

What is a Credit Builder Loan?

A Credit Builder loan refer to a loan that is generally given for a period ranging from 6 months to 24 months. The loan has to be repaid by the borrower in 12 monthly installments. These funds are held by the bank so you cannot spend the amount while you are making monthly installments. However, you get the money after the entire loan amount is cleared off.

These loans are normally granted by commercial organizations that operate on a small scale such as, small local banks and credit unions. Not many people know about these Credit Builder Loans because they are not marketed as much as other loans. There are online lenders that provide the same facilities as well. However, all the terms and conditions of the loan must be confirmed before approval. 

How do These Loans Develop Your Credit Rating?

The main priority of Credit Builder Loans is to focus on building credit firstly and then on borrowing credit. 

  • Credit Builder Loans are given for a short period of time to borrowers in order to enhance their credit rating. This will eventually help you to get approved for different kinds of loans in the future as most other types of loans require a sound history of credit.

  • The amount that an individual has borrowed is put into a guarded savings account.

  • After you have successfully paid all the installments on time, the funds that were kept frozen for you are transferred to your savings account.

  • The credit reference agencies obtain a detailed report of all the intricate aspects of your payments from the credit suppliers. Based on your data, these credit agencies calculate your credit rating. It is advisable when applying for credit, to check thoroughly whether the data is accurate.

  • These companies emphasize on a sound uk credit score as it is an indication of your financial trustworthiness.

If we look at Credit Builder Loans from the perspective of the credit supplier, it becomes obvious that lenders exercise more caution while lending money on the account of it being a risky concern. They prefer to advance loans to those individuals who they think will repay the amount on time. When applying for a Credit Builder Loan, a person does not necessarily require a great credit history. The credit suppliers provide the loan without actually jeopardizing their financial safety. It has two-fold benefits for the individual as it helps in creating credit and saving money at the same time.

How does Skipping Payments affect Credit Rating?

When making timely payments (installments), it will be beneficial and can assist you to establish a solid credit history. You will have to showcase yourself as a person who is trustworthy as well as responsible in financial matters like credit handling. A credit history constitutes about 35% of a person’s credit rating. 

This implies that poor credit history can have an impact on your credit rating. If you miss a payment, it will reflect on your credit rating. When a person does not have a mature credit history, the impact will be felt even more as it would pull down your credit rating significantly.

It is important to note that credit suppliers communicate everything regarding your monetary behavior to the credit reference agencies (Experian, Equifax and TransUnion). On account of this, it is essential to ensure all payments are made on time with due interest.

However, paying off the Credit Builder Loan beforehand is permitted by many of the credit suppliers. This is because when an individual repays the loan before the period is completed, they are cutting short their credit history of payments. The idea of the Credit Builder Loan itself is to develop a sound credit history but when paid off early, cannot help create a good credit history.

How Effective is a Credit Builder Loan?

A Credit Builder Loan is only effective when the payments are consistently made on time and these payments should be reported with accuracy to the credit reference agencies. The effectiveness of these loans depends on the individual itself. If these loans are used carefully, they can prove to be a solid preliminary stage for establishing a comprehensive credit history after which, you will be suitable for other kinds of credit with ease. 

Moreover, they are generally economical i.e. less expensive as compared to other loans or credit cards when it comes to their interest rates. In most cases, 50% of the interest payments are refunded back when payments are made on time.

What are the Types of Credit Builder Loans?

There are 2 main types of Credit Builder Loans which are listed below.

Pure Loans

This type of Credit Builder Loans require you to deposit the whole amount of the loan in your savings account. The credit agency ensures that until you pay the complete amount of the loan in monthly installments, it will remain frozen. Hence, there is no primary deposit required. 

Share Secured Loans

A share secured loan, on the other hand are those kind of loans where the individual will be required to deposit money in their savings account which is equal to the amount of loan approved. The credit supplier will have control over the savings account, when the money is paid back in the form of monthly installments, the shares equivalent to that installment are unfrozen for the individual to use.

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