Qualifying for unsecured loans or credit cards can be difficult without an established credit history, a Catch-22 that can frustrate those just starting out. Credit builder loans can help borrowers prove they can handle debt, thus making them safer risks for other credit products in the future. Typically these are issued by credit unions. If you're a member of one, or eligible to join one, this product can help you meet your financial goals. Some small community banks also offer these loans.
How They Work
Credit builder loans typically are for small amounts, often between $500 and $1,500. In general, credit builder loans work in one of two ways.
Secured by Savings
A credit union might require the borrower to place money in a savings account or CD. The borrower then takes out a loan for that amount. You'll have to fill out a loan application and demonstrate that you have the available funds. In many cases, the application can be done online, though you may have to speak to a representative over the phone or in person to complete the process. You may get interest or dividends on the funds.
Money on Layaway
In other cases, the credit builder loan operates like a layaway plan. The payments are placed in an interest-bearing account by the credit union. You get access to the money when the scheduled loan payments are finished. Sometimes, the lender deposits the entire amount of the loan in a CD, and get it only when the payments are complete.
When applying for a credit builder loan, confirm that the credit union reports the account's activity to the major credit bureaus.
Because credit builder loans are for those trying to establish or rebuild their credit, qualification isn't as involved as it is for other loans. Income and employment verification standards may be less strict, and your credit history may not be considered at all. The risk for the lender is low, since you're effectively either borrowing your own money or funding the loan with each monthly payment. The amount you'll be able to borrow, and the interest you pay depend on your credit history.
Signing the Contract
Check the loan terms before signing a loan agreement. That will spell out how much your payments will be, when they are due and how long it will take to pay off your balance. Interest rates may vary between different credit unions in the same area. The lower your rate, the less this credit-building product ultimately costs you. In addition, some offer features like automatic payroll deduction to make loan repayments more convenient.