If your credit is poor or nonexistent, you may not qualify for the types of accounts (credit cards, personal loans, etc.) that could help you build it. This is one of the many frustrations of The United States credit systembut there are a few discrete ways to improve it.
One of them is, appropriately, called a “credit builder” loan. These small installment loans are usually offered by credit unions and some banks, and they can help boost your score a bit if you make payments on time.
How it works
According to NerdWallet, you may also see credit builder loans advertised as “fresh start loans” or “start on loans”. To take out one, you will need to prove that you have enough income to make payments on time. For a “pure” secured loan, the credit union holds the amount you borrow, usually $500 to $1,500, by CreditCards.com‘s Allie Johnson – frozen in a savings account, then you make payments each month, which are reported to Equifax, Experian and Transunion, the three major credit bureaus.
When fully repaid, you also get accrued interest. That’s what sets it apart from other types of loans, says Greg McBride, The bank ratechief financial analyst. This is also why it is not available at all financial institutions – credit unions offer them as a service to their members.
There’s also an unsecured version, which gives you a small amount of money up front, usually for an unexpected expense, and you pay it back through an automatic funds transfer. These can be a good alternative to payday loans, writes Johnson.
Payment history is most important component your FICO credit score, which means on-time payments reported could help boost your score, of course, there’s no magic formula that will take you from, say, 550 to 750. “If you’re recovering from bankruptcy or a series of delinquencies, it’s a step in the right direction, but it’s not a panacea,” says McBride.
Another important factor is your credit mix, which makes up 10% of your FICO score. Adding an installment loan can help with this if you only have, say, one credit card.
What to look for
If you decide this makes sense to you, you’ll want to do your homework. You don’t want to stretch too much – taking out a much larger loan amount is worth no more to the credit bureaus than a smaller, more manageable sum – and you want the term to be no longer than 24 months, for example. NerdWallet.
So make sure you know all the details before signing up. “Get details about any loan you’re considering, including how it works, whether you need to post collateral, the interest rate, monthly payment amount, and whether payments are reported promptly to all three credit bureaus,” Johnson writes. .
Again, if you can’t repay the loan in a timely manner, within 30 days of its due date, you could hurt your credit even more. So it’s something you only want to do if you’re sure you can pay it back on time.
But also remember that you don’t want to rush the payment. Building credit takes time, that’s the interest on the loan. So if it’s a 12 month loan, recognize that you need to make payments for 12 months for it to be most effective, even if you have the ability to pay it back sooner. If you need a quick credit fix, this isn’t for you.
Other Ways to Build Credit
If that sounds complicated, here are three more ways to build your credit:
- Pay overdue accounts: Collections amounts will not be removed immediately upon refund, but a refunded invoice is considered more favorably than an overdue invoice. And be sure to check your score for errors or black marks that can be removed.
- Apply for a secure credit card: “As long as you pay off the balance in full each month, you don’t have to worry about interest charges,” says McBride. “But stay away from those with big application fees and annual fees.”
- Become an authorized user on a family member’s card: But remember that you are both responsible for the payments and both of your credit ratings will be affected.
But if none of that works, there might be some recourse in a credit builder loan, especially if you’re young and have no credit. Again, make sure you have the funds to pay it back on time, otherwise it will do more harm than good.
“It’s a good option if you’re in a situation where you’re looking to establish or rebuild your credit,” McBride says. “If the shoe fits, wear it.”