Using Credit Builder Loans to Improve Your Credit Score

If you want to improve your credit, a credit builder loan may be a good option to pursue. Learn how they work and get other tips to improve your score.Building your credit can be an important financial step if you’re looking to buy a home, finance a car, or obtain better interest rates for a cheaper loan. However, not everyone wants to use credit cards (and not everyone is eligible for a credit card) to build their credit.

This is where credit building loans come into play! Credit building loans are exactly what they sound like: they help you build your credit as you pay the loan down. If you’re interested in learning how it works, here are a few tips to get you started with a credit builder loan.

Understanding Credit Builder Loans

Borrowers just getting started, whether they’re young and have no credit, or have been working to improve their credit score, should know the strategy behind using a credit builder loan isn’t for everyone.

For one, credit builder loans are additional debt you take on with the goal of improving your credit score. They’re available as installment loans or as lines of credit. Many people don’t see this as a good strategy since it adds to your debt totals.

If you have existing debt, a credit builder loan may not be appropriate for your situation. Instead, you should focus on paying down your debt, consolidating debt, and negotiating lower interest rates. Using these other methods to improve your score may be a slow-and-steady fix, but they’re easier to control since there’s less temptation to spend on new credit lines.

However, having existing debt doesn’t mean you won’t benefit from a credit builder loan, which you can get through either a bank or credit union. As credit scoring guru John Ulzheimer put it in a New York Times article on credit builder loans, these types of loans “are offered as a way for credit union members to do a couple of things: get something good on their credit reports and set aside some money for future use.”

Credit builder loans are usually smaller loans, and many require an upfront cash payment to secure the loan. This upfront payment is often put in a savings account and can be accessed after the debt is paid.

If the loan isn’t paid in full, the lender keeps the upfront payment and may collect on fees for the loan, which is all the more reason to be very careful in your decision to take on more debt if you’re trying to improve your credit.

Unsecured debt, on the other hand, has no collateral and the borrower is required to pay the loan in full or face severe penalties for late or nonpayment. (This will damage your credit score even further.)

How Does a Credit Builder Loan Help My Credit Score?

Seeking a credit builder loan takes a little bit of research on the borrower’s part. One step you ought to consider in your search is if the lender is established with all three credit bureaus.

According to Cardratings.com, you get the maximum credit building benefit from having the loan at a bank or credit union tied to all three credit bureaus. If your loan is only reported to one, for example, you might not get the boost you want from taking out the loan.

As with any kind of debt, making regular payments (which are reported to credit bureaus) will boost your credit score. Having a credit builder loan does just that!

Worried you’ll miss a payment? You should be. According to CreditNet, 35% of your FICO credit score comes from payment history. Since the goal of your credit building loan is to improve your credit, you don’t want to risk missing your payment due date.

Instead of worrying about a missed payment or forgetting to mark your calendar, set up automatic payments with your bank or credit union to cover at least the minimum amount, and then make extra payments if you’re able to. This way, you’ll be covered on the minimum balance and any extra payments are gravy!

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What Else Improves My Credit Score?

If a credit builder loan isn’t right for you, or you don’t want to take on more debt, there are still many ways to improve your credit score. Experian offers the following tips which can go a long way in improving your score:

  • Make timely bill payments – As stated previously, paying your bills on time, including debt payments and utilities, goes a long way towards improving your credit score. If you struggle with this, review your budget and schedule bills ahead of time so you know you won’t miss a payment.
  • Maintain low credit card and loan balances – Your debt to income ratio is an important factor in your credit score. Keeping lower balances on your credit ensures credit bureaus you’re a responsible borrower. You could even try to ask for an increase in your credit line to improve your debt to credit ratio. While paying down debt is optimal, this may be a temporary strategy to help with your score.
  • Apply for new credit as needed – While many people believe opening a variety of credit lines, such as loans and credit cards, can help your score, there’s a good chance they’ll hurt your budget and have little impact in the long run. Only open new credit when you need it.
  • Pay off debt – This is a no-brainer, but for many people, it can be hard to achieve this goal. Paying your balances down, rather than moving them around or closing credit cards you no longer use, will improve your credit. Some ways to do this include paying more than the minimum balance, using a method like the snowball method, or paying more than once per month.
  • Regularly check your credit reports – You may not know it, but the activity on your credit reports may be inaccurate, greatly impacting your overall score. If you check your reports at least once a year against your existing accounts and records, you’ll be well on your way to fixing any discrepancies and improving your score.

If you fear your credit needs fixing, a credit builder loan may do the trick. However, consider all your options and determine if the loan is right for you once you’ve done your research on other debt repayment and credit improvement options.

Have you ever had to improve your credit score before? What tips worked best for you?

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