Trying to Fix Your Credit? This Unorthodox Loan May Be the Answer

Build credit with a loan that your bank keeps for you

Fact checked by Betsy Petrick

If you’ve got poor credit, you may feel at a loss for improving it. After all, you may not qualify for credit cards or lines of credit that, when used responsibly, could boost your credit score. Fortunately, there is an unusual loan you can take out that can help boost your credit score. Credit-builder loans are personal loans designed to help people rebuild their credit history or improve their credit scores. When you repay these loans, the loan issuer reports your payment activity to credit bureaus, which will update your scores.

Key Takeaways

• Making regular on-time payments is one of the biggest factors affecting your credit score.
• Taking out a credit-builder loan and making repayments helps you build credit since your issuer reports responsible use.
• There are many kinds of secured loans, which are backed by collateral like a home or car. Repaying a secured loan according to the loan terms can also build your credit.

What Is a Credit Builder Loan?

You might not have heard of a credit builder loan, but these are typically offered by smaller banks and credit unions. Essentially, you borrow money that the bank holds onto until you’ve paid off the loan. The loan servicer creates a payment plan and asks you to make regular, on-time payments. The servicer then reports these payments to credit monitoring bureaus. Once you’ve finished making payments, you’ll get your funds, plus any interest earned.

According to Experian (one of the three credit monitoring bureaus), making on-time payments accounts for 35% of your FICO score. This makes it the single most important factor in determining your credit score. So, taking out a credit-builder loan and being diligent about the payments is a very effective way to repair your credit.

Note

Credit bureaus also look at how much debt to income you have, the length of your accounts, the mix of credit types, and how often you’ve applied for credit when determining your credit score.

Alternatives to a Credit Builder Loan

If you don’t like the sound of a credit builder loan, you do have other options.

• Secured credit card: When you apply for this type of credit card, you deposit money into the account. This becomes your credit limit. You can improve your credit if you use the secured credit card responsibly.
• Student credit card: These cards are easier for students to qualify for since they usually only require income verification (instead of a decent credit score). You might be required to have a co-signer, though.
• Car title loan: If you own your car outright, you can use the title as collateral to take out a loan. Since the interest rates for these loans are high, they’re not a great way to rebuild your credit, even though they’re a solid option for quickly obtaining funds.
• CD-secured loan: This is similar to a car title loan—if you have a certificate of deposit, you can use it as collateral to secure a loan. Again, the terms aren’t favorable since you risk losing your CD and you may face early withdrawal penalties.
• Share or savings account-secured loans: Instead of using a car title or CD as collateral for a personal loan, this type of secured loan uses money in a savings account to secure funds.

Important Considerations

Before you apply for a secured or credit builder loan, there are a few things you should be aware of.

Make Payments on Time

Missing a credit card or loan payment every once in a while might not seem like a huge deal, but it can have a big impact on your credit score. Even missing just one payment could cause your score to take a hit.

If you struggle to remember when repayments are due, set up auto-payments or electronic reminders so you can log in and pay your loans.

Be Aware of Interest Rates and APRs

If your credit score has room for improvement, you might be excited to have any loan application approved, but not so fast. Read the loan’s terms and conditions—specifically, the interest rates and annual percentage rates (APR). The interest rate is the cost of borrowing the principal, while the APR includes the interest rate plus other fees associated with taking out the loan.

Compare your loan offers, taking into account the overall cost of each. You’ll probably want to choose the loan with the lowest interest rate or APR since it will cost you less in the long run.

The Bottom Line

Unfortunately, there aren’t any quick fixes for fixing your credit score, but making regular payments toward a credit builder or secured loan can repair your credit over time. While you’re making payments, practice good financial habits like checking your credit report for errors and only applying for credit that you need.