How to build your credit by taking a loan - MoneyTap
How to build your credit by taking a loan
What Is A Credit Builder Loan And How It Improves The Credit Score
Shiv Nanda
Sep 15 • 5 mins read

What Is A Credit Builder Loan And How It Improves The Credit Score

5 mins read

We all know that a good credit score plays a vital role in securing credit from banks and financial institutions. However, it is only possible to build a healthy credit score with a spotless credit history which might not be achievable for people like fresh graduates, new immigrants, people who skipped a loan repayment deadline due to an emergency, and many others. In such a scenario, a credit-builder loan or essentially a loan to build credit comes to the rescue.

Credit builder loans allow people with no previous credit history or bad credit history to take a loan and build a credit score. This credit is not provided immediately to the borrower but instead transferred to a savings account which the borrower must pay for in full to access.

It is imperative to have a good credit score to access credit cards and get approval for bank loans, however, that is not the case with credit builder loans. This makes it the perfect alternative for people who have no credit history to start building their credit score.

A credit builder loan is especially helpful for the following groups of people

  • People looking for a fresh line of credit
  • People who want to improve their credit history and credit score
  • People who do not have any existing credit score
  • People who want to clear their existing loan advances

A credit builder loan helps the customer pay off outstanding loans, improve credit score, and increase their chances of securing new credit easily in the future.

A credit builder loan is different from a general bank loan because the customer does not get paid the loan amount, upfront. The amount is deposited in a savings account and can only be accessed when the loan is repaid in full. So one needs to repay the loan to get the money, rather than getting the money first and paying it off later. Credit builder loans hold this amount in the bank account as a collateral, making it less risky for the lender.

Why Should You Use A Credit Builder Loan?

A credit builder loan can be used for a number of reasons, some of which are discussed below

  • Helps kick-start credit: Starting the process of building credit is extremely tedious. Groups such as fresh graduates, immigrants, or generally people with no credit history or a bleak credit history can benefit greatly from a credit builder loan. Also, in many cases, a credit builder loan may be the only source of credit available to people with no pre-existing credit history.
  • Helps improve credit: A credit builder loan can help build the credit score without the additional risk of taking on large amounts of debt. With an improved credit score, one can avail of various benefits such as lower interest rates on loans, higher credit card limit, and many others.
  • Helps rebuild credit: Life is unpredictable and change is the only constant. Unforeseen events such as bankruptcy, divorce, health ailments can put a dent in the credit score. In such a scenario, getting a credit builder loan presents a way to rebuild the credit score from scratch.

How Can I Secure A Credit Builder Loan?

  • Find the right credit builder loan: You can approach financial institutions and banks for a credit builder loan, and can also look for options online. You must check for overhead charges and interest charged so as to not overpay.
  • Get documents in order: The next step is to get the documentation required for the loan in order. Some proof of income, identity documents, banking details, and other documents will be needed.
  • Decide loan amount: A credit-builder loan usually means a smaller loan amount than other loans. You must ensure that the amount borrowed can easily be paid back on time. Even one missed deadline for payment can cause immense damage to the credit score.
  • Apply for loan amount: Once all the documents are ready, applying for the loan is a smooth process. You can apply for the same in person or online.
  • Open a savings account: Once your loan request gets approved, the lender opens a savings account on your behalf and transfers the loan amount to the same. However, you can not access these funds until and unless the loan amount has been paid in full.
  • Pay monthly instalments: You need to pay monthly instalments for the loan amount borrowed. These instalments depend on the total amount, interest rate, and the tenure of the loan amount.
  • Collect your funds: Once the amount is paid in full, you can collect the funds from the bank account. Lenders may even return the interest charged on the loan amount.

Quickest Way To Build Credit Score

  • Timely payment: Ensure that the due amount is paid within the set duration. This is the most important metric for your credit score.
  • Ask for a higher credit limit: If you have a higher credit limit and your usage remains consistent, you lower your credit utilization ratio which helps improve the credit score.
  • Dispute errors: Keep a constant check on your credit card statement and dispute any errors or wrong charges.
  • Mix it up: Mix up your credit sources. Try incorporating different kinds of credit to improve your creditworthiness.

Benefits Of Getting A Credit Builder Loan

There are multiple benefits of a credit builder loan, including

  • Line of credit: Banks do not provide loans to people with a low credit score or no existing credit history. but they can easily secure a line of credit using a credit builder loan.
  • Build credit score: A credit builder loan helps you build your credit score and later avail benefits of credit from banks at lower interest rates.
  • Improve credit score: For people with a low credit score, a credit builder loan can help significantly improve their credit score.

What Other Options Are Available To Build Credit?

Apart from credit builder loans, there exist other options to rebuild your credit score, including

  • Secured credit card: Using a credit card can help build credit score provided the monthly installments are paid on time.
  • Secured loan: A secured loan requires one to submit an asset as a collateral. However, people with no existing credit history or low credit score might find it hard to secure one.
  • Unsecured loan: You need to pay a higher rate of interest on an unsecured loan as the lender faces a high risk of giving out the loan without a collateral.
  • Co-signer on loan: If someone has a low credit score, he/she can get a co-signer for their approved loan amount approved. As the co-signer also shares the onus of paying back the loan amount, it is easier to get credit and build credit score.

FAQs

  1. Can getting a loan improve my credit score?

    Yes, although it depends on how you use the loan availed. A personal loan can contribute by showcasing a better credit mix, and having a wide range of different types of credit can in turn boost the credit score. It also helps in building a payment history, which if positive, can increase your credit score. As a personal loan is not considered while calculating the credit utilization ratio, it can be used to clear any outstanding dues on credit card, which will impact the credit utilization ratio. This will improve your credit score.

  2. How long do you need to have a loan to build your credit score?

    You can easily build a good credit score within about 6 months.

  3. What is the fastest way to build my credit score?

    Some quick ways to build your credit score include paying bills on time, undertaking frequent payments or transactions, becoming an authorized owner of a credit card and asking for higher credit card limits, and making on-time payments towards loan installments.

  4. Can personal loans hurt my credit score?

    A part of the application process for a personal loan requires the lenders to do a credit check on you, the result of which is a hard inquiry on your credit report. This hard inquiry has the likelihood of negatively impacting your credit rating – too many of which could damage your credit score. A personal loan can also put you in a cycle of debt, if you are taking the loan just to pay back any existing higher interest borrowings.

  5. Can credit cards and personal loans really help to build my credit score?

    Yes. Having a credit card means that your transactions or information related to your spending and repayment are more frequently reported to the credit bureaus. Personal loans, on the other hand, show a diversified credit portfolio. Paying the loan installments on a timely basis will further help in building a strong credit score.

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