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A credit builder loan is a type of loan that helps you rebuild poor credit or establish credit for the first time. Its sole purpose is to help you raise your credit score, and having a good credit score—or even any score at all—isn’t required to apply for one.
Taking out a credit builder loan means borrowing a specific sum of money—but you don’t have access to the funds. Instead, it gets deposited into a savings account that you can’t access until your loan term ends and you’ve made all of your payments.
How do credit builder loans work?
A common issue people face when trying to improve their credit is the inability to qualify for a loan or a credit card—an essential component to building credit. If you carry poor credit, lenders are less inclined to lend you money. But if you can’t get approved by any lenders, you never get the chance to build up your credit.
A credit builder loan is a low-risk way for lenders to loan money to those with poor credit, while also providing people the chance to build a strong credit history.
A credit builder loan functions in the opposite way of a traditional loan. Instead of gaining immediate access to funds that are repaid later, the money you borrow gets set aside in a secured savings account while you make monthly payments toward the balance. This allows you to make consistent, on-time payments on the loan that will show up on your credit report, thus improving your credit score.
How can credit builder loans raise my credit score?
As with any other type of loan, responsible credit usage is key to improving your credit score. Lenders will report the payments you make on a credit builder loan to at least one of the major credit bureaus, who will then put this information in your credit report.
If you make your payments on time for the duration of the loan, you show that you’re a reliable borrower. This is reflected on your credit report, which is what your credit score is based on. Keep in mind that since this isn’t a traditional loan, making your payments early won’t have any advantages over just paying your monthly balance on the agreed-upon schedule.
While you might start off with a low credit score, a year or two of responsible borrowing with this kind of loan will help those numbers rise. Payment history is a critical credit scoring factor—it accounts for 35 percent of your FICO® score. By responsibly managing a credit builder loan, you have the chance to build a positive payment history.
How much does it cost?
Costs will always vary by lender, so it’s important to shop around and compare options to find the best rate. Here are some of the common costs to expect with a credit builder loan:
- Administrative fees: An administrative fee of $8 – $15 is usually required before you can qualify for the loan.
- Interest rates: Credit builder loans come with interest, and the rate will vary depending on your lender and your unique credit history. Typical interest costs are usually between six and 16 percent.
- Payments: The cost of your monthly payments depends on how much you choose to borrow. Most loan amounts might be anywhere from $300 to $1,000—choose an amount
Is a credit builder loan worth it?
The answer to this question will always depend on your unique financial situation. A credit builder loan can be a helpful tool if you need to build your credit from the ground up or improve a poor credit score. Here are some things to consider that might indicate a credit builder loan wouldn’t be your best option for building credit:
- You need access to funds right away: Remember that a credit builder loan works in the reverse way of a traditional loan. Instead of using the loan to access borrowed funds, you’ll be contributing your funds to a secured savings account that you can’t access until the loan term is up. If you’re looking to take out a loan because you need immediate funding, a credit builder loan won’t help you.
- You don’t have enough money to dedicate to a credit builder loan: A credit builder loan will only improve your credit score if you make your payments consistently and on time for the duration of the loan. If you have to stretch your budget in order to fund a credit builder loan, you risk missing a payment and ultimately damaging your score. Make sure you can afford to contribute to this type of loan before committing to it.
Where to get a credit builder loan
Credit builder loans are offered by many financial institutions, including credit unions and local banks. You usually won’t find them at big banks, as credit builder loans aren’t profitable enough and are rarely advertised. Check these places instead:
Credit unions: To get a loan from a credit union, you need to become a member. Common membership requirements include living in the area where the credit union is based or working for a certain company. You might also have to pay a membership fee.
Community banks: Smaller, local banks usually offer credit builder loans as well. You can search for local banks in your area and call them to inquire about what types of loans they provide.
Online lenders: It’s possible to find online lenders who offer credit builder loans, and finance companies are becoming aware of the benefits of offering them.
Wherever you decide to go, make sure their lender reports payments to at least one of the major credit bureaus: Experian®, Equifax® and TransUnion®. Ideally, they report to all three—this is necessary in order to have your payment history reflected on your credit report.
How else can I increase my credit score?
A credit builder loan isn’t the only way to build credit. Even if you have a poor credit score, there are other options to improve your credit standing.
Secured credit cards
This is a great option for poor credit carriers because approval is basically guaranteed. The only requirement is a cash deposit, which also becomes your credit limit. Your activity on a secured credit card gets reported to the credit bureaus just like with a credit builder loan, so you have the opportunity to demonstrate a positive repayment history and boost your credit score.
Become an authorized user
If you can’t qualify for a credit card of your own, a low-risk way to build credit is to become an authorized user on someone else’s credit card. This allows you to use the credit card owner’s line of credit, but the card owner is the only one responsible for payment. If you have a friend or family member who’s willing to add you to their card—and they have responsible credit usage habits—their payments and activity will appear on both of your credit reports, giving you the chance to raise your score.
Secured personal loan
A secured personal loan requires you to put up collateral in order to borrow funds. This makes it less risky for lenders to loan to you, since they can seize your collateral if you don’t make your payments as scheduled. While this is an option to build up your credit, the possibility of losing your collateral makes it riskier.
Unsecured personal loan
This type of loan isn’t backed by collateral, but interest rates are typically much higher, making this a more expensive way to build your credit. They’re also harder to get approved for since the lack of collateral means a higher risk for lenders. You might need a slightly higher credit score to qualify for an unsecured loan, and you can expect to pay more interest on it than you would on a secured loan.
Is a credit builder loan right for me?
Your credit score influences almost all of the major financial decisions you’ll make in a lifetime. Maintaining a good credit standing will impact your ability to finance things like a car, a home or a college education. If you have a poor credit history, finding ways to improve your credit score is a responsible and worthwhile goal.
A credit builder loan can be a helpful tool if you need to build your credit from the ground up or improve a poor credit score. Remember that this type of loan won’t give you immediate access to any funds, so keep this in mind when deciding whether or not it’s right for you. But if you have a small sum of money you can afford to part with, putting it toward a credit builder loan is certainly an option to start or improve your credit building journey.
Empowering yourself financially requires discipline and patience, especially if you’re climbing out of a bad credit history. But the possibility of financial freedom exists for anyone willing to commit to the process, and there are many resources available to help you along the way. The consultants at Lexington Law can provide you with tools to help you secure a better financial future and guide you through your credit building journey.
Does Getting Joint Credit Cards Have an Impact on Both Spouses’ Credit?
While marriage can help you improve your financial situation, it does not automatically mean that you and your spouse will share a credit report. Your credit records will remain separate, and any joint accounts or joint loans that you open will appear on both of your reports. While this can be advantageous, it’s critical to remember that joint account activity can effect both of your credit scores positively or negatively, just as separate accounts do.
Users Who Are Authorized
An authorized user is a user who has been added to an existing credit account and has been granted the authority to make purchases. Authorized users are typically issued a card bearing their name, and any purchases made by them will appear on your statement. The primary distinction between an authorized user and a shared account owner is that the account’s original owner is solely responsible for debt repayment. Authorized users, on the other hand, can always opt-out of their authorized status, although the principal joint account owner cannot.
If your credit score is better than your spouse’s as an authorized user, he or she may benefit from a credit score raise upon account addition. This is contingent upon your creditor notifying the credit bureaus of permitted user activity. If your lender does report authorized users, the activity on your account may have an effect on both you and your spouse. However, some lenders report only positive authorized user information, which means that late payment or poor usage may not have a negative effect on someone else’s credit. Consult your lender to determine how authorized users on your account are treated.
Joint Credit Cards Have an Impact on Your Credit Score
Opening a joint credit account or obtaining joint financing binds both of you legally to the debt’s repayment. This is critical to remember if you divorce or separate and your spouse refuses to make payments, even if previously agreed upon. It makes no difference who is “responsible,” the shared duty will result in both partners’ credit histories being badly impacted by late payments. Regardless of changes in relationship status or divorce order, the creditor considers both parties to be liable for the debt until the account is paid in full.
Whether you’re happily married or divorced, you and your spouse may decide to open separate credit accounts. Most creditors will enable you to transfer an account that was previously joint to one of your names if both of you agree. However, if there is a debt on the account, your lender may refuse to remove your spouse’s name unless you can qualify for the same credit on your own. Depending on your financial status, qualifying for financing and credit on a single income may be tough.
While creating the majority of your accounts jointly with your spouse may make it easier to obtain financing (two salaries are preferable to one), reestablishing credit independently following a divorce or separation is not always straightforward. To make matters worse, your spouse may wind up causing significant damage to your credit rating following the separation, either intentionally or through irresponsibility – making the financial situation much more difficult.
Before you rush in and open accounts with your spouse, take some time to discuss the shared responsibility of these accounts and what you and your husband would do in the event of a worst-case situation. These types of financial discussions can be difficult, especially when you rely on items lasting a long time, but a mutual understanding and respect for each other’s credit can go a long way toward keeping your score when sharing an account.
Should you pay down debt or save for retirement?
While establishing a comprehensive, workable budget is undeniably one of the most important factors in maintaining a healthy financial life, it can also be one of the most difficult. For those who are struggling with personal debt, building a budget can be particularly challenging. When the money coming in has to stretch like a contortionist to cover expenses, it can be hard to determine where to focus — and where to trim.
Sometimes, the battle of the budget can come down to a choice between dealing with the present — and thinking about the future. When your income is running out of stretch, do you pay off your existing debt, or do you start saving for retirement? At the end of the day, the solution to that particular dilemma depends on the type of debt you have and how far you are from retiring.
If you have high-interest debt, pay it down
When considering how to allocate your budget, it’s important to understand the different kinds of debt you may have. Consumer debt can be categorized into two basic types: low-interest debt and high-interest debt, each with its own impact on your credit (and your budget).
In general, low-interest debt consists of long-term or secured loans that carry a single-digit interest rate, such as a mortgage or auto loan. Though no debt is the only real form of good debt, low-interest debt can be useful to carry. For instance, purchasing a home with a low-interest mortgage can actually save you money on housing costs if you do your homework and buy a house well within your price range.
High-interest debt, on the other hand, typically has a hefty double-digit interest rate and shorter loan terms, such as that of a credit card or payday loan. High-interest debt is the most expensive kind of debt to carry from month to month and should always be priority number one when building a budget.
To illustrate why you should focus on high-interest debt above everything else, consider a credit card carrying the average 19% APR and a $10,000 balance. If the balance goes unpaid, that high-interest credit card debt will cost $1,900 a year in interest payments alone. Now, compare that to the stock market’s average annual return of 7%, and it becomes clear that you’ll see significantly more bang for your buck by putting any extra funds into your high-interest debt instead of an investment account.
If you are having trouble paying off your high-interest debt, there may be some steps you can take to make it more manageable. For example, transferring your credit card balances from high-interest cards to ones offering an introductory 0% APR can eliminate interest payments for 12 months or more. While many of the best balance transfer cards won’t charge you an annual fee, they may charge a balance transfer fee, so do your research. You’ll also want to make sure you have a plan to pay off the new card before your introductory period ends.
Most balance transfer offers will require you to have at least fair credit, so if your credit score needs some work, you may not qualify. In this case, refinancing your high-interest debt with a personal loan that has a lower interest rate may be your best bet. Make sure to compare all of the top bad credit loans to find the best interest rate and loan terms.
If you’re nearing retirement, start to save
The closer you get to retirement age, the more important it becomes to ensure you have adequate retirement savings — and the more pressure you may feel to invest every spare penny into your retirement fund. No matter your age, however, paying off your high-interest debt should always remain the priority, as it will always provide the best rate of return (as well as likely provide a credit score boost).
Indeed, no matter how tempting it becomes, you should avoid reallocating money you’ve dedicated to paying off high-interest debt to save for retirement. Instead, the focus should be on re-evaluating your budget to find any additional savings you can. To be successful, you will need to make a strong distinction between want and need — and, perhaps, make some tough lifestyle choices.
Though simply eliminating your daily coffee drink won’t magically provide a solid retirement fund, saving a few bucks by homebrewing while also eliminating a pricey cable bill in favor of an inexpensive streaming service — or, better yet, free library rentals — can add up to big savings over the course of the year. The ideal strategy will involve overhauling every aspect of your lifestyle, combining both large and small cuts to develop a lean budget structured around your long-term goals.
Of course, while you should never allocate debt money to your retirement savings, the reverse is also true. It is almost always a horrible idea to remove money from your retirement account before you hit retirement age — for any reason. Withdrawing early means you will be stuck paying hefty fees for withdrawing money early and, depending on the type of account, you may also have to pay significant taxes.
Aim for both goals by improving income
As you take the necessary steps to pay off debt and save for retirement, you may have already stretched the budget so thin it’s practically transparent. In this case, it is time to consider ways to improve your overall income. Increasing the amount you have coming in not only provides extra savings to put toward your retirement, but may also speed up your journey to becoming debt-free.
The easiest solution may be to look for ways to increase your income through your current job; think about taking on additional shifts or overtime hours to earn some extra cash. Depending on your position — and the time you’ve been with the company — consider asking for a pay raise or promotion, as well.
If you do not have options to make more money at your day job, it may be time to find a second job. Look for opportunities that provide flexible schedules that will accommodate your regular job; many work-from-home positions, for example, can easily fit into most work schedules. Doing neighborhood odd jobs, such as babysitting and dog walking, may also provide a solid income boost without interfering with your existing job.
For some, the need to pay off debt and improve retirement savings can be more than just a source of stress — but a hidden opportunity to begin a new career adventure. Instead of being weighed down by yet more work, use the desire to better your budget as a reason to explore the profit potential of a passion or hobby. Starting a small online store, part-time consulting service, or other small business can be a great way to improve your income and your overall happiness.
While it may sound intimidating, starting a side business can be as simple as putting together a professional looking website and doing a little marketing legwork to spread the word. And no, building a website isn’t as scary — or expensive — as it seems, either. A number of the top website builders now offer simple drag-and-drop interfaces perfect for putting together a professional-looking web page in minutes (without breaking the bank).
How does a loan default affect my credit?
Nobody takes out a loan expecting to default on it. Despite their best intentions, people sometimes find themselves struggling to pay off their loans. These types of struggles happen for many reasons, including job loss, significant debt, or a medical or personal crisis.
Making late payments or having a loan fall into default can add pressure to other personal struggles. Before finding yourself in a desperate situation, understanding how a loan default can impact your credit is necessary to avoid negative consequences.
30 days late
Missing one payment can further lower your credit score. If you can pay the past due amount plus applicable late fees, you may be able to mitigate the damage to your credit, if you make all other payments as expected.
The trouble starts when you (1) miss a payment, (2) do not pay it at all, and (3) continue to miss subsequent payments. If those actions happen, the loan falls into default.
More than 30 days late
Payments that are more than 30 days past due can trigger increasingly serious consequences:
- The loan default may appear on your credit reports. It will likely lower your credit score, which most creditors and lenders use to review credit applications.
- You may receive phone calls and letters from creditors demanding payment.
- If you still do not pay, the account could be sent to collections. The debt collector seeks payment from you, sometimes using aggressive measures.
Then, the collection account can remain on your credit report for up to seven years. This action can damage your creditworthiness for future loan or credit card applications. Also, it may be a deciding factor when obtaining basic necessities, such as utilities or a mobile phone.
Other ways a default can hurt you
Hurting your credit score is reason enough to avoid a loan default. Some of the other actions creditors can take to collect payment or claim collateral are also quite serious:
- If you default on a car loan, the creditor can repossess your car.
- If you default on a mortgage, you could be forced to foreclose on your home.
- In some cases, you could be sued for payment and have a court judgment entered against you.
- You could face bankruptcy.
Any of these additional consequences can plague your credit score for years and hinder your efforts to secure your financial future.
How to avoid a loan default
Your options to avoid a loan default depend upon the type of loan you have and the nature of your personal circumstances. For example:
- For student loans, research deferment or forbearance options. Both options permit you to temporarily stop making payments or pay a lesser amount per month.
- For a mortgage, ask the lender if a loan modification is available. Changing the loan from an adjustable rate to a fixed rate, or extend the life of the loan so your monthly payments are smaller.
Generally, you can avoid a loan default by exercising common sense: buy only what you need and can afford, keep a steady job that earns enough income to cover your expenses, and keep the rest of your debts low.
Clean up your credit
The hard reality is that defaulting on a loan is unpleasant. It can negatively affect your credit profile for years. Through patience and perseverance, you can repair the damage to your credit and improve your standing over time.
Consulting with a credit repair law firm can help you address these issues and get your credit back on track. At Lexington Law, we offer a free credit report summary and consultation. Call us today at 1-855-255-0139.
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