ADVERTISEMENT

How do credit-builder loans work?

By  |  Published: December 28, 2016

Opening Credits
Columnist Erica Sandberg
Erica Sandberg is a prominent personal finance authority and author of "Expecting Money: The Essential Financial Plan for New and Growing Families." She writes "Opening Credits," a weekly reader Q&A column about issues for people who are new to credit, for CreditCards.com.

Ask a question.

'Opening Credits' stories

Question Dear Opening Credits,
I hope you can help get me out of my confusing circle. First, I’m new to the credit world. I want to start to build a good credit history to be able to get a student loan next year. I visited several credit unions and they suggested a secured personal loan. Would that be a good way to start to build credit, and will a secured loan help create a good credit history like a regular credit card? And the money I borrow, if it is a small amount and with six months to repay it, is that long enough to create a good credit history? – Sam

Answer

Dear Sam,
I agree, the credit sphere can be baffling when you are just starting out. So here is how it works. And yes, it may behoove you to begin with that credit union loan.

First, know that in order to have a credit history, information about you must be listed on a consumer credit report. These reports are produced by three major credit reporting agencies: TransUnion, Equifax and Experian. Their role is to compile data that lenders and other furnishers send to them, which includes your borrowing and repayment activity, as well as any debts that have gone to collection agencies or for which you’ve been sued for nonpayment. Financial institutions, landlords, insurance companies, employers (if they get your approval first and employer credit checks are not barred or restricted by law), and any other businesses with a legitimate purpose can check your credit reports to see what you owe and how you handle accounts.

The secured loan product you mention is a fine way to add positive information to your credit report. With a credit-builder loan, you borrow a specific sum, but you don’t have access to the funds. Instead, the credit union deposits the money in a type of savings account, and will report to the agencies the amount you borrowed.

When you begin repaying, they’ll send your payment pattern and the steadily declining balance information to the credit bureaus. If you pay on time and in total, your credit reports will show that and you’ll be well on your way to creating a great credit history.

Be sure to ask about the fees and interest associated with the loan, as they’re not free. Once you complete all the payments, you’ll get your money back.

A credit-builder loan isn’t the only way to jump-start your credit history. Secured cards also will work. Your card’s credit line is secured by a deposit you submit to the card issuer. In case you don’t pay, the issuer can tap those funds for repayment. Check the array of secured cards available on CreditCards.com to people with limited credit history. If you have extra funds that you can tie up for a year, consider a secured card. Just use the card properly:

  • Charge something once per month that is less than 30 percent of the credit limit. For example, if the card limit is $500, the charge should be no more than $150.
  • Send your payment before the due date.
  • Pay the entire bill in full.

Now let’s talk credit scores. After you’ve started building a credit history and have some trade lines in use, a credit score will be developed. FICO and VantageScore are the two most commonly used scores, and both range from 300 to 850. The higher the scores the better, as high scores indicate a long and positive history of using credit products.

In the beginning, your scores will be on the low end, but after a year or so of responsible borrowing and repaying, those numbers will rise quickly. Remember that payment history and the amount of debt you carry as compared to the amount you can borrow are the two most critical scoring factors, but length of credit history, types of credit in use and pursuit of credit are also calculated in your score. You can’t make time speed up, but you can assemble a few good credit products to prove that you can handle multiple accounts. Apply only for credit products you know you can get, since hard inquiries triggered by your credit application will lower your credit score.

You can keep an eye on your VantageScore (and access your TransUnion credit report) for free at my.creditcards.com. You can see your FICO credit score (also for free) at Discover Scorecard. Pulling either your credit scores or credit reports does not hurt your credit, by the way.

Regarding student loans, if they’re federal and used for an undergraduate education, good credit scores are unnecessary as they’re not a qualification factor. However, if you need private loans for graduate school or trade schools, credit scores are checked. Raising your credit score now will ensure all opportunities are open to you in the future.

See related: 9 things to know about secured cards, How to build credit with a student loan

Meet CreditCards.com's reader Q&A experts

Does a personal finance problem have you worried? Monday through Saturday, CreditCards.com's Q&A experts answer questions from readers. Ask a question, or click on any expert to see their previous answers.

ADVERTISEMENT
ADVERTISEMENT

Join the discussion
We encourage an active and insightful conversation among our users. Please help us keep our community civil and respectful. For your safety, do not disclose confidential or personal information such as bank account numbers or social security numbers. Anything you post may be disclosed, published, transmitted or reused.

If you are commenting using a Facebook account, your profile information may be displayed with your comment depending on your privacy settings. By leaving the 'Post to Facebook' box selected, your comment will be published to your Facebook profile in addition to the space below.

The editorial content on CreditCards.com is not sponsored by any bank or credit card issuer. The journalists in the editorial department are separate from the company's business operations. The comments posted below are not provided, reviewed or approved by any company mentioned in our editorial content. Additionally, any companies mentioned in the content do not assume responsibility to ensure that all posts and/or questions are answered.




Updated: 08-18-2017

ADVERTISEMENT


Weekly newsletter
Get the latest news, advice, articles and tips delivered to your inbox. It's FREE.


ADVERTISEMENT