The Best Kept Secret to Building Credit
Building your credit score can be intimidating, expensive, or both. And your options may seem limited; either take out a loan or open a credit card. These products can offer an unpleasant mix of fees, interest, and debt. Luckily there's an alternative; the secured credit-building loan. It's the savings plan that also helps you build your credit score.
Wait! What is a secured credit-building loan?
In a nutshell, it's like a savings plan, that also builds your credit. Though technically a loan, you don't receive cash up front. Instead, you commit to a savings target, and monthly savings plan to reach that target over a year or two. Once you pick your target and savings schedule, the lender puts an amount equal to your savings target (aka the loan principal) into a locked account, and you start saving towards this amount. As you make your regular monthly savings payments, the lender reports these to credit bureaus as principal payments, building your on-time payment history and credit profile.
Why haven't I heard of this?!
You're not alone, most people are in the same boat. For starters, secured credit-builders often go by another name, like a “fresh start loan” or “second chance loan.” And unfortunately, most financial institutions push you other products that they make more money on. Credit-builders are generally only available through credit unions or smaller community banks.
I'm interested, but is this right for me?
Secured credit-builders work well for most people, but especially if:
You're new to banking or just starting to build credit. Everyone has to start somewhere. Maybe you're finishing up school and about to get your first job. Maybe you're just realizing the importance of building credit.
You have a damage credit file or low score. No one is perfect, and life is full of surprises. If you fell behind on payments, or have some high-cost debt that you're struggling to pay down, building your credit profile can help you get on the right track.
When you want a credit score, but not a credit card. Credit cards can help you build your score, but having too many can hurt, and tempt you to overspend. A secured credit-building loan can help you build credit, without putting you in the hole.
What's the downside?
Because the credit builder loan is secured, it's lower risk to the lender, which means lower interest rates on the loan. However, there are typically still fees and interest charges for a credit builder. Before opening one, be sure to understand the fees, interest, and total APR, your monthly payment, what credit bureaus the lender will report to, and whether there is a penalty for closing the account early.
Where can I find a credit building loan?
Ask your bank or credit union about whether they offer the product. About 15% of credit unions and a handful of community banks do. A few start-ups are also beginning to offer the service. Lastly, check out Motiv's credit-builder, which is free for active account holders.