If you have a poor credit score or a limited credit history, you may consider a credit builder loan. So, let’s have a look at how these loans work.
What is a Credit Builder Loan?
Credit builder loans are a type of unsecured loan (not backed by collateral) intended to help people improve their credit score.
Credit builder loans are best suited towards those with poor credit scores or a lack of credit history.
They usually have a loan term of 6-24 months, with a maximum loan amount of £5,000. They usually aren’t offered by mainstream banks and lenders.
How do they Work?
To be approved for a credit builder loan, you don’t need to have a good credit score, but lenders will require you to have enough income to make payments. You have to be able to afford the loan.
With typical loans, you borrow money upfront and then pay this back to the lender over a set period of time with the addition of interest. Credit builder loans work quite differently; with these, the lender usually requires that you make payments first before receiving the full loan amount.
Some lenders will offer the money upfront but many prefer to release the payment to you near or at the end of your loan term. So, the lender sets aside money in a savings account which you then pay towards every month in instalments. Then, at the end of the loan term you are granted access to the balance.
Why do People use Credit Builder Loans?
With credit builder loans, the lender usually reports your payment history to the credit bureaus. So, if you made each payment in full and on time, this looks good on your credit history.
Therefore, in the future you will be more likely to be approved for credit and access lower interest rates for things like car finance, mortgages, credit cards, and so on. This is because you have shown that you can be responsible with your money and make payments on time.
Even though credit builder loans operate quite differently to typical loans, they are still indeed loans. This means that you will still pay interest on your instalments and may also have to pay administrative fees.
Consequently, they can work out as an expensive way of building your credit score. Time is one thing that can help your credit score, as most information stays on your credit history for up to 7 years (though bankruptcy can stay there for 10 years). We speak more about other things that help your credit score here.