Enhancing your credit score is a valuable financial move, particularly when you’re considering purchasing a home, financing a car, or securing a more affordable loan. However, credit cards—which are commonly used to build credit—aren’t an option for everyone, due to personal preferences or eligibility issues. That’s where credit-building loans come into the picture. If you would like to understand their functionality better, here are some key tips to help you get started with a credit builder loan.
DECODING CREDIT BUILDER LOANS
Individuals new to credit—be they young people without a credit history or those working on enhancing their credit score—should understand that utilizing a credit builder loan is not a strategy that works for everyone.
Simply put, credit builder loans are additional debts that you accrue with the aim of augmenting your credit score. They come in the form of installment loans or credit lines. For some, taking on additional debt isn’t seen as a beneficial strategy as it increases your total debts.
If you are already under considerable debt, getting a credit builder loan might not suit your circumstances. Instead, focusing on paying off existing debt, consolidating your debts, and negotiating for lower interest rates may be more fruitful. These methods may not be quick fixes, but they are easier to manage as they don’t encourage additional spending.
That being said, current debt does not automatically exclude you from the potential benefits of a credit builder loan, available through banks or credit unions. According to credit score expert John Ulzheimer in a New York Times article, these loans can offer credit union members valuable credit report augmentation and provide a means of saving money for future use.
Typically, credit builder loans are smaller in size. They often necessitate an upfront cash payment to secure the loan, which generally gets saved in an account and can be accessed once the debt is cleared.
However, if the loan is not paid in full, the lender retains the upfront payment and might amass fees for the loan. Hence, it’s crucial that you be extremely cautious about taking on additional debt as a means to improve your credit.
Furthermore, unsecured debt, which lacks collateral, requires the borrower to pay off the loan in full or endure severe penalties for late or absent payments. (This can further dampen your credit score.)
ELUCIDATING HOW A CREDIT BUILDER LOAN IMPROVES YOUR CREDIT SCORE?
Availing a credit builder loan entails research on the borrower’s part. Ensure that your lender collaborates with all three credit bureaus, as recommended by Cardratings.com, to get the maximum credit-building advantage. A loan that is only reported to a single credit bureau may not offer the credit boost you seek.
Regular payments on your debt—which are reported to credit bureaus—will enhance your credit score, and having a credit builder loan allows you to do exactly that.
Concerned about missing a payment? You have good reason to be—payment history accounts for 35% of your FICO credit score, as stated by CreditNet. As your goal is to better your credit score with your loan, it’s essential to avoid late payments or defaults.
To mitigate the risk of missed payments or payment delays, create an automatic payment plan with your bank or credit union, suggesting paying atleast the minimum required amount, plus make additional payments if possible. By doing so, you guarantee payment of your minimum balance and any added payments are a bonus!
OTHER FACTORS BOOSTING MY CREDIT SCORE?
If a credit builder loan isn’t the right fit, numerous alternative methods exist for elevating your credit score. Experian suggests:
Ensuring on-time bill payments – Timely payment of bills and debts positively impact your credit score. If this is a struggle, restructure your budget and devise a way to ensure you never miss a payment.
Maintaining low credit card and loan balances – Your debt-to-income ratio significantly impacts your credit score. Responsibly managing your credit by sustaining low balances ensures your reliability to credit bureaus.
Applying for credit only when required – Though it’s commonly believed that opening multiple credit lines enhances scores, it often wreaks havoc on budgets and might minimally impact your credit in the long run.
Paying off debt – While this sounds obvious, it can often be challenging. Proactively paying down balances, rather than shuffling them around or closing unused credit cards, can boost your credit score. There are various ways to do this, including paying more than the minimum due, employing techniques like the snowball method, or making multiple payments in a month.
Peridocially reviewing your credit reports – Unrecorded activity on your credit reports can severely hamper your score. Regular yearly checks against your existing accounts and records can ensure discrepancies are rectified, thereby enhancing your score.
If you’re concerned your credit might need an overhaul, opting for a credit builder loan might be a solution. But consider all available alternatives before deciding whether such a loan is right for you.
Have you previously attempted to revive your credit score? What strategies worked best for you?
