Looking for a quick way to re-activate or build credit without a credit card? Consider a credit builder loan.
"A credit builder loan is actually a loan. It just happens to have the by-product of helping to establish or re-establish credit," says John Ulzheimer, credit expert at CreditSesame.com. "You might pay $100, $95, $75 a month, depending on the amount you borrowed."
Credit builder loans appeal to people who don't want to use credit cards to build credit and who would rather do business with a credit union than a big bank, Ulzheimer says.
How it works
A credit builder loan is an installment loan reported to one or more of the three big credit bureaus, says Sarah Chenven, director of programs and strategic initiatives for Credit Builders Alliance. Best practice for credit builder loans is a minimum six-month term, with terms generally ranging from 12 to 18 months.
"Active, on-time monthly payments on a loan will establish a positive payment history and therefore build or rebuild your credit," Chenven says.
Credit builder loans generally work in two ways, according to Chenven.
"Upon making the loan, the lender places the money in a 'locked' savings account on the borrower's behalf. The borrower then repays the loan in monthly installments and has access to the funds once the loan is paid off," Chenven says. "In some cases, a borrower gives the lender cash upfront which is placed in a savings account as collateral for the loan, much like a secured credit card. Unlike with a secured credit card, however, the borrower does not have access to the full or majority of the savings amount, but rather pays down the loan in monthly installments more like a line of credit."
At Dupaco Community Credit Union in Dubuque, Iowa, credit builder loans usually range between $500 to $1,500 with a 12-month term or less.
"The money that is borrowed is secured in the member's savings account for the term on the loan," says Ben Wagner, Dupaco relationship development specialist. "Payments are made directly through payroll deduction. This sets up a solid repayment plan that is reported to the member's credit."
Loan serves other purposes
Jill Rothenberger, Dupaco lending consultant supervisor, says many members use credit builder loans to meet savings goals.
"Most members have a goal to save for a down payment on a vehicle or a home, some may just want to save for the holidays," she says.
Rothenberger says there are several advantages to credit builder loans for members.
"The member gets to establish a trade line that reports on their credit report, they establish payment history with the credit union, and they establish money in savings that they can use for any purpose at the end of the loan," she says. "If they do not need the funds for anything they can re-allocate what they were paying to the loan to the savings account and continue to build their savings for when that rainy day comes."
Some things to consider
There are some disadvantages to credit builder loans to consider, especially if you fail to make payments, Chenven says.
"If you are late or default on a credit builder loan payment it will be reflected on your credit report and in your credit score," Chenven says. "Furthermore, credit builder loans are not free. Lenders usually charge interest or at least an application and sometimes late payment fees."
And there may be limited availability of credit builder loans in your area, Ulzheimer says.
"Not all credit unions offer them and you can't join all credit unions anyway because of membership requirements," Ulzheimer says.
To maximize your credit building, it is a good idea to seek out a lender that reports to all three credit reporting agencies, which isn't always the norm, Ulzheimer says.
"Then you are getting the maximum credit building benefit out of the loan," he says.