Building credit is not an easy goal to achieve especially when there might be instances when you’ve failed to keep up with your obligations. In effect, this may have severely impacted on your credit score. With a low credit score, it’ll be harder to access financing from banks, and lenders will be hesitant to give you a loan.
But fortunately, there are opportunities like a credit builder loan that can help you build or restore your credit score. In this article, you’ll learn more about this loan and how it can help you make good credit standing. Moreover, you’ll also have a glimpse of the computations of the monthly payments and the preparation of loan amortization.
What Is a Credit Builder Loan?
A credit builder “loan” isn’t exactly a loan. In traditional loans, you enter into an agreement with the creditor. In return, the creditor will give you money, and your obligation is to repay the amount at the maturity date. But, a credit builder loan doesn’t share the same characteristics as a traditional loan.
Think of a credit builder loan as advanced savings. When you invest in something, you get something in return. And most often, returns come at a future date. If you relate that to a credit builder loan, the creditor will loan you an amount. But here’s the catch. Instead of giving the money to you, the creditor will keep it somewhere like in a bank account or an escrow deposit.
How Does A Credit Builder Loan Work?
A credit builder loan works differently than the usual loan. When getting a traditional loan, the lender will give you the money and pay it on a certain date. However, the opposite is true for a credit builder loan. Instead of getting the money upfront, the lender will require you to pay it first before giving you the amount.
For example, you took a credit builder loan with a principal amount of $1,000. Instead of receiving the $1,000 now, you’ll have to pay it first before receiving it. Depending on the interest rates and agreement with the bank or financial institutions, you’ll have to keep up with the monthly payments until the maturity.
Now, where does the money go? Everytime you pay your monthly amortization, the creditor will place it in an account where you can’t access the amount unless you’re done with the monthly payments. So, this is definitely not similar to a regular savings account. A credit builder loan is stricter since you can’t use the accumulated money anytime you want.
This may seem odd but that’s the very essence of a credit builder loan. So, how will it benefit you? It’s simple. Every time you make payments, the lender will take note of that. In effect, they’ll report to the credit bureaus that you’ve made consistent and on-time payments for the duration of the loan. In your credit report, future lenders will see your outstanding record, and applying for a loan will be much easier.
Getting a Credit Builder Loan
Now, your question must be, “how do I get a credit builder loan?” You won’t find these types of loans at commercial banks. Only community banks and credit unions offer this type of loan as one of their main service lines. Below are some companies that offer a credit builder loan:
- Republic Bank
- Heartland Bank
- Self
- Metro Credit Union
- Digital Federal Credit Union
- USAlliance Financial Credit Union
You can visit the websites above to see their credit repair programs. If you wish to continue with your chosen institution’s credit repair services, you may contact them using the number provided on their website or visit the branch nearest to you. You’ll know most of the details during the processing of your application.
Does Bad Credit Affect the Approval of this Loan?
No! A credit builder loan is perfect for people with bad or no credit at all. The purpose of this loan is to build your credit. So if your credit score is low, this type of loan can help make it higher. Credit builder loans have no credit check mechanisms. If credit checks are required for this loan, then it defeats its very purpose.
What Are the Requirements for this Loan?
Every financial institution has set a list of requirements for the loan. So, it’s best to ask the financial institution or visit their website for more information. But, here’s the good thing. Good credit is not required for this loan. However, you need to state your monthly income as needed.
Pros of a Credit Builder Loan
| 1. Easier to Get than Personal Loans Whether secured or unsecured, a credit builder loan application is far easier than a personal loan application. In a credit builder loan, requirements are minimal and financial institutions aren’t strict for this type of loan. Instead, financial institutions would love a credit builder loan because it gives them an additional source of cash. |
| 2. Helps Develop Your Financial Habits A credit builder loan is a good exercise for your personal financial planning, cash management, and budgeting. Considering that you’ll be making monthly payments, you’ll be trained to properly allocate your resources and help you budget it without compromising your living conditions and relationships. |
| 3. Improves Your Credit Score The financial institution will act as a “recorder” of your payments. Every time you make a payment, they’ll take note of it and put it on their credit report. And when they report it to a credit bureau, you’ll have a sparkling credit history that lenders would love to see. |
| 4. Gives a Decent Amount of Money in the End Your monthly payments go to a savings account. It means that you’ll receive a decent sum after you finish paying off the loan. It’s more like a future fund or a short-term investment. Perhaps you can call it a “prepaid loan” because you’ve already paid it before enjoying it. |
Cons of a Credit Builder Loan
| 1. Interest Rates Tend to be High For credit builder loans, interest rates usually are high. That’s why it’s important to find the best loan term out there. If you’re looking for a lender, don’t just settle on the first or one institution. Check out other companies as well. You can do this by looking at their websites, inquiring on their services, reading flyers or pamphlets, and checking customer reviews. |
| 2. Memberships may be Required In the case of credit unions, their policy may require you to be a member of their organization. This requirement is treated as a “con” because you’ll be bound once you join the union. It means that you may have to participate in their activities and pay dues if needed. |
| 3. Money Isn’t Accessible Until the Loan is Repaid Yes, you only get the money when you finish paying off the loan. You can’t ask for an advance payout because that would violate the agreement. If you’re in a tight spot right now, it’s best not to take a credit builder loan because it entails a strict financial commitment. |
How To Compute the Monthly Payment of a Credit Builder Loan?
Knowing the monthly payment of your loan is crucial. If you want to know the mathematical process behind this, pay attention to the instructions in this section. Normally, loans like this one use an amortization table. This table shows how much interest you pay per month and how much is deducted from the principal amount.
Loan Term and Monthly Payments
Knowing the monthly payment of your credit builder loan can help you budget your monthly expenses. You can click this link to access an online loan calculator that’ll automatically compute your monthly payments, total interest paid, and total payments for the duration of the loan.
The loan term and your monthly payments have an inverse relationship. If your loan term is long, you’ll have smaller monthly payments.
Amortizing a Credit Builder Loan
Knowing the monthly payment is essential in completing the amortization table for your credit builder loan. This section aims to show you how an amortization table will look like. The amortization table for the first six months on a $15,000 loan should look like this:
| Date | Payment | Interest | Principal | Balance |
| – | 15,000.00 | |||
| January | 1,332.00 | 150.00 | 1,182.00 | 13,818.00 |
| February | 1,332.00 | 138.18 | 1,193.82 | 12,624.18 |
| March | 1,332.00 | 126.24 | 1,205.76 | 11,418.42 |
| April | 1,332.00 | 114.18 | 1,217.82 | 10,200.60 |
| May | 1,332.00 | 102.00 | 1,230.00 | 8,970.60 |
| June | 1,332.00 | 89.17 | 1,224.30 | 7,728.30 |
Take note that your monthly payments remain the same throughout. Only the principal and interest change every month. But, how did we arrive at the amounts? Here is the formula:
- Interest = Outstanding Balance x Monthly Interest Rate
- Principal = Payment – Interest
In January, the outstanding balance is $15,000, and it earns an interest of $150 (15,000 x 1%). In the next month, the unpaid balance would be $13,818. Multiply that with the monthly rate, and your interest payment for February is $138.18.
Take note that monthly payments consist of two portions: the interest portion and the principal portion. Meaning, the whole $1,332 doesn’t go to the principal. Instead, a portion goes first to the interest. So if you look in June, you’re paying $89.71 interest expense, and only $1,224.30 goes to the principal.
But as you reach the end of the term, the interest payments decrease, and principal amortization increases. Did you notice that?
So, what can you learn from the example above? Here are some key takeaways:
- The longer the loan term, the higher the interest payments.
- As you reach the end of the term, you’re paying less interest than during the early stages, and amortization to the principal increases.
- Longer loan terms decrease the monthly payments.
Final Words
A credit builder loan can help you restore your credit standing. But it has its advantages and disadvantages. This type of loan can help you recover from a financial setback where your credit score has been badly impacted. However, that would only work if you fully commit to it and try not to accumulate more debts along the way. There are many financial institutions out there offering this kind of loan. Before signing an agreement, shop around first and look for the best offer.
Aidan has been writing about personal finance for over 6 years. Prior to this, he worked as a Corporate Finance Analyst where he specialized in Due Diligence, Company Valuations and more. He is a CFA charterholder.
