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Britt Erica Tunick is an award winning financial journalist who has spent the past 17 years writing about virtually every aspect of finance.

Bad Credit? Why You May Want to Consider a Credit-Builder Loan

Bad Credit? Why You May Want to Consider a Credit-Builder Loan

By Britt Erica Tunick

Few things are as important as a good credit score when it comes to your finances. But how do you improve a bad credit history, or prove to creditors that you are a good bet when you don’t yet have a credit history? One way of doing so is through a credit-builder loan.

Credit-builder loans are basically sophisticated savings accounts where an individual is actually saving up the amount they will ultimately “borrow” by committing to make monthly payments to their “lender” over a pre-determined time period. Unlike traditional loans, however, where a lender disburses the loan amount to the borrower at the start of the contract, the borrower gradually pays toward the total loan amount through monthly loan payments —money that is deposited into a certificate of deposit or some other secured savings vehicle to earn interest on behalf of the borrower until the loan term is complete. It is important to note, however, that most credit-builder loans only repay a portion of the interest earned to the account holder, so this is something to look carefully at when taking out such a loan. And even though the borrower is actually paying toward money they will ultimately receive, they still have to pay an annual percentage rate (APR) that is tied to such loans, and which can range anywhere from 6% to 16%. Such loans typically range from anywhere from $250 to $3,000 and last from between six months to two years.

In the simplest terms, a credit-builder loan is essentially a dry run for a borrower to prove to a lender that they are capable of maintaining regular and timely monthly payments on a loan. As with typical loans, payment activity is reported to the credit bureaus. Regular and timely payments will reflect well on an individual’s credit score, whereas missed or late payments can have a detrimental effect. Given this reality, it is important to make sure you do not take out a loan for more than you can truly afford to make monthly payments on, as any payment that is 30 days or more late will harm your credit score. If a credit-builder loan is paid on time throughout the term of the loan, it can help improve a credit score anywhere from 60 to 100 points, depending on an individual’s credit history and the amount and length of the loan.

If a credit-builder loan is something you believe can help you, make sure to shop around before committing. There can be a wide variance in the APR charged by financial institutions, as well as the amount of interest you will get back.