Credit builder loan: A smart way to improve your credit score
Your credit score is one of the most important factors in managing your personal financial life, as it influences everything from loan eligibility to interest rates.
However, for many people, whether they have a low credit score or no credit history at all, building a credit score from the ground up can seem like an insurmountable task. Fortunately, there are tools from various companies, such as a credit builder loan by Koho, that are specifically designed to help those looking to improve or establish credit gradually. In this article, we’ll explore what a credit builder loan is, how it works, and the advantages it offers to those looking to improve their financial footing.
What is a credit builder loan?
A credit builder loan is a financial product designed to help individuals with little to no credit or a low credit score build their credit rating. Unlike a typical loan where the borrower receives a lump sum upfront upon approval, with a credit builder loan, the lender keeps the loan amount in an interest-bearing account, such as a CD or savings account.
The borrower cannot access the money until the loan is paid off in full, but they make fixed monthly payments over the course of the loan term. The lender then reports these payments to the major credit bureaus (Equifax, Experian, and TransUnion), which allows the borrower to build a credit history, assuming payments are made as promised.
At the end of the loan term, the borrower not only will have built a credit history but will also gain access to the funds that were held in the savings account. Credit builder loans are a useful tool for those looking to demonstrate responsible credit use over an extended period and can help boost credit scores in many cases.
How do credit builder loans work?
A credit builder loan works as follows: a lender does not lend the borrower the money directly. Instead, the lender deposits the loan funds into a savings account, typically a CD or savings account. The borrower then agrees to make fixed monthly payments to the lender in exchange for access to the loan funds, which are held in the secured savings account.
Once the borrower has paid off the loan amount (which can range from six to 24 months, depending on the loan terms), they will be granted access to the loan funds, and the entire payment history is reported to the credit bureaus. If the borrower has made timely and full payments, their credit score will increase.
Credit builder loans are typically small amounts, usually between $300 and $1,000, depending on the bank. Interest rates and terms vary but are often lower than those of payday loans. These loans are a great option for consumers who are looking to build credit from scratch or improve their credit score after a financial setback.
Benefits of credit builder loans
Building Credit
The main benefit of a credit builder loan is the ability to build or rebuild your credit. Your credit score improves with each on-time payment, making it easier to qualify for low-interest loans in the future, such as a mortgage or auto loan.
Low-Interest Rates
Many credit builder loans have lower interest rates compared to payday loans or high-interest credit cards. For consumers looking to improve their credit score without incurring large amounts of debt, a credit builder loan may be a better, less expensive option.
No Credit Check Required
Most credit builder loan programs do not require a credit check, making them accessible to individuals with low or no credit. This gives those who have previously been denied access to credit the chance to prove they are creditworthy.
Forced Savings
Credit builder loans act as a type of forced savings plan. The loan amount is deposited into a locked savings account or CD, and you’ll only be able to access it once the loan is paid off. This ensures you save the amount you borrowed each month.
Learning Good Financial Habits
Taking out a credit builder loan can help you learn about the lending process, budgeting, and managing debt. It’s a good practice run for other loans in the future.
Is a credit builder loan right for me?
A credit builder loan is an excellent option for those looking to improve their credit score without taking on significant debt. However, it’s important to ensure you can afford the monthly payments before taking out the loan. If you’re uncertain, consider consulting a financial advisor to help determine if a credit builder loan aligns with your financial goals.
