Americans who are struggling to establish a credit record or want to improve their credit score, if they have no debt, could find the solution in a so-called “credit builder loan”, according to the Consumer Financial Protection Bureau (CFPB).
The findings, which are sure to be noted with interest by regular users of the best credit report services, come following a survey of 1,531 credit union members who were offered a financial institution’s credit builder loan, or CBL for short. According to the research, participants without an existing loan who opened a CBL increased their likelihood of having a credit score by 24%. At the same time, those without existing debt saw their credit scores increase by 60 points more than participants with existing debt.
Why could the findings prove important?
According to the bureau, around 26 million U.S. adults - or one in ten - have no credit record and are “credit invisible.” Meanwhile, a further 19 million have a credit record but no score, because their history is too thin or out-of-date.
Without a credit score, consumers tend to face greater difficulty in accessing credit or else will be charged much higher rates when trying to take out a personal loan and other credit products, such as a mortgage or an auto loan.
With the coronavirus pandemic causing household debt to rise across the U.S. and many households having little option but to turn to credit cards and loans to help bridge financial gaps, credit scores are assuming an ever greater importance.
The recent launch of a new credit score aimed at improving people’s chances of getting a loan looks set to help those borrowers who have found themselves excluded from the best credit deals due to the uncertainty created by COVID-19. However, with credit builder loans an established part of the market already, they could prove a more immediate solution for those looking to establish or improve a credit record.
How does a credit builder loan work?
Importantly, a credit builder loan is not like a traditional loan - in fact, it is more akin to a savings account that allows you to build your credit score at the same time. Indeed, according to the CFPB report, a credit builder loan resulted in an average increase in participants’ savings balances of $253.
When you apply, the lender puts the loan balance you choose into a savings account. You will then be expected to make fixed payments towards it over a number of months, before the lender returns to you the total balance (plus the interest you paid, potentially) at the end of the loan term. A CBL will typically be for between $300 to $1,000, according to the CFPB, with installments usually paid over a period of six to 24 months.
As you won’t be able to access this money until the term is up, choose a loan amount with an easily affordable monthly payment. To improve your credit score with a CBL, repaying the loan on time is more important than its size.
While you will pay interest on the loan, a portion of this may be returned to you by the lender at the end of the loan term in the guise of "dividends". As with any financial product, though, understanding exactly what you are signing up to is key, particularly in relation to interest rate, any fees that might be charged, and whether you can expect to receive a dividend.
Where can you get a credit builder loan?
Credit builder loans tend not to be available through the larger financial institutions. Instead, you will typically find them offered by credit unions, small banks, online lenders and nonprofit organizations. Each will have its own requirements and have questions over your income and circumstances. However, some lenders won’t advertise that they offer CBLs, so you are always best to ask.
How do you open a credit builder loan?
It is sometimes possible to apply for a CBL without having to undergo a traditional credit check. Rather than using your credit score, some lenders will consult your banking history instead before approving a loan - in this instance, things such as bounced checks might count against you.
As to what you might be asked to provide, most lenders will require evidence of at least some or all of the following:
- Employment details
- Pretax monthly income
- Pay stubs, or tax returns if self-employed
- Total cost of housing
- Other loan balances
- Balances in checking and savings accounts.
Is a credit builder loan suitable for everyone?
The quick answer is no. The research conducted by the CFPB is definitely encouraging for those with no existing credit record and people without debt who want to boost their credit score, although there can still be no cast-iron assurances that a CBL will be effective for you.
Importantly, however, the report also indicated that taking out a CBL appeared to cause a decrease in credit scores among those with existing debt. And on average, those with existing loans saw their scores decrease slightly, a trend that the CFPB suggests demonstrates the difficulties that affected borrowers experienced in incorporating CBL payments into their existing payment obligations.
How else can you improve your credit score?
While a credit building loan might therefore prove a good option to establish a credit score, or improve one if you have no other debt, there are other steps that should always be considered if you want to better your creditworthiness.
Always try to pay your bills promptly, and if you can’t, make your best effort to meet the minimum payment before any due date to avoid accruing damaging marks on your credit report. Settling any debt you have almost always helps lenders to see you in a more favorable light too - so if you fear what you owe is hurting your credit score, maybe approach the best debt consolidation companies to see whether they can help. If you regularly apply for credit, it is also wise to leave at least six months between applications, so as not to arouse suspicion among lenders over your motives and potential to repay.
Obviously, monitoring your credit situation with the best credit report services will help you keep an eye on how you are doing and raise any potential areas of concern. If there is something on there that you disagree with, or if you’ve exhausted all other avenues without huge success in improving your credit rating, the best credit repair services might be able to help by getting errors removed from your credit report, and guiding you towards a healthier credit standing.