Published: 14 November 2023
Updated: 12 February 2024
Author: Noah Gomez
Credit builder loans (also known as "freedom," "fresh start," & "starter" loans) boost credit with user-friendly installment debt while creating savings using secured deposits.
Because CBLs are technically secured personal loans, they provide safety and flexibility without the commitment and constraints that come with conventional loans.
Credit builder loans (CBLs) were designed to improve below-average credit, but their structure offers benefits for virtually any borrower. In addition to better credit and a chunk of savings, benefits range from penalty-free cancellation to widespread availability via regional banks, credit unions, and online lenders.
Unfortunately, some lenders impose hidden and severe conditions that only surface after it's too late. Moreover, some lenders promote CBLs as overnight credit solutions, whereas the reality is they work best when combined with revolving credit in carefully-planned builder programs.
Credit builder loans improve 60% of credit factors AND accept borrowers with subprime profiles, using a combination of cash collateral and alternative creditworthiness metrics.
Credit builder loans are inexpensive installment debt with flexible acceptance & cancellation terms designed for Americans who want to improve their credit without the stiff commitment and higher rates associated with car, home and other "purchase" loans.
Credit builder loans create powerful credit profiles, and strong profiles help in virtually every aspect of life from renting and working to buying cars and insuring them.
Some landlords require a copy of your credit report and score to determine whether prospective tenants are trustworthy.
Some argue that rent has nothing to do with credit, which originated as a vetting system for debt lenders. Regardless, landlords have a legal right to request and use credit as a reason to deny tenants.
Credit builder loans not only improve the overall profile, but also show landlords you know how to manage payments over time versus a prospective tenant who only uses secured credit cards.
Borrowers with zero credit history or negative marks can be outright denied for critical auto and mortgage loans. Lenders want to see consumers are mature and trustworthy, and the only way to prove worth is by establishing thick, reliable credit reports.
Credit builder loans provide hard evidence that consumers know how to manage debt to be reimbursed consistently each month.
Lenders approve loans for borrowers who meet the minimum requirements, then they determine interest rate. Even 1% lower interest can save $100,000+ for the average consumer, and anyone can get there by further thickening their report.
Credit builder loans, especially when combined with builder cards, can turn weak or damaged credit into the ideal profile that simply commands the best rates.
Some employers check your credit before and during employment to monitor the risk that employees engage in delinquent activity or need to suddenly quit their job. Consumers with poor credit may struggle to clear the screening process.
Credit builder loans help establish a trustworthy profile and score employers feel comfortable hiring and keeping on board.
Some states allow insurance providers to pull consumer credit reports in order to determine riskiness, and therefore the appropriate insurance premium. Consumers with weak credit pay higher premiums because insurers assume their management of debt equates to management of the insured asset, especially a car with an active loan.
Credit builder loans not only improve score and therefore lower insurance payments, but also provide evidence of responsible installment debt management that insurers can trust.
Entrepreneurs need partners and financing, and most will check the businesses credit to determine its trustworthiness. When the business is just starting, it's credit is often the same as its owner's profile. Poor credit can therefore be a deal breaker.
The positive effect of credit builder loans on credit profile helps prevent unnecessary business failures due to technicalities, which can be painful for founders who would otherwise build thriving companies.
A major frustration from living with average credit is that it's not bad enough for lenders to deny, but not good enough to compel quick decisions.
Borrowers with average or just below-average credit face this dilemma. The impact is more than just stress because in many circumstances speed is an essential quality to buy a home or car.
This is one reason lenders like Ava promise results within two weeks.
Credit builder loans appear as secured personal loans that lenders value in their own right, compelling them to act swiftly.
Credit builder loans impact all 5 credit factors, but they have notably strong impact on payment history (35%), credit mix (10%), and account age (15%).
Payment history (35%). Each on-time installment payment demonstrates the ability to plan for and remember debt payments, which is the most important element for lenders.
An easy way to understand why is to imagine lending to a friend. You may be interested in his/her past payments and relationships with other lenders, but at the end of the day you want your money back more than anything.
Credit mix (10%). Borrowers have only two choices for borrowing: revolving and installment. Revolving credit is money you borrow and pay back on a regular basis, usually month (e.g. credit cards). Installment credit is a lump sum paid back over a fixed period of time.
Consumers must use both to get the best interest rates because responsible use of each structure demonstrates a strong understanding of debt mechanics. Credit builders are a type of installment credit.
Account Age (15%). Account age, also know as length of account history, refers to the average length of all cards & loans AND the age of the oldest account. For example, you may have 1 account from 3 years ago but 2 account from 1.5 year ago. Your average age is therefore 2 [(3 + 1.5 + 1.5) / 3], and your oldest account is 3.
This is the reason it is so important to front-load your profile with credit builder loans to reap the rewards months in the future.
Overall, approximately 30% of credit builder loans do not check credit reports. Lenders are able to do this because they use varying degrees of cash-collateral to mitigate their risk.
For example, about 25% of payment-secured CBLs (the most common) do not check credit because each installment doubles as collateral.
Moreover, about 23% of unsecured CBLs (that provide money up front) do not check credit, and the figure jumps to nearly 99% of fully-secured CBLs because they require 100% of collateral deposited at the start of the loan.
Of the three credit builder loans types, unsecured are most attractive for borrowers with poor credit and a need for cash. They use alternative creditworthiness metrics to approve and fund borrowers who are refused elsewhere. In other words, they don't require any cash up front.
On the flip side of the spectrum are fully-secured types. These CBLs require the borrower deposit the full amount of the loan principal at the start from which installment payments are made. They impose the highest cash constraint on borrowers in exchange for very low effort.
In the middle are payment-secured CBLs, which are ideal for borrowers who want to improve their credit but don't need cash to fund a purchase. Each installment payment doubles as cash collateral, so the borrower obtain low rates, builds savings, and doesn't need to front a sum of cash.
The standard credit builder loan, called payment-secured, builds savings with a clever collateral structure. The lender technically distributes the principal amount into a locked savings or certificate of deposit account.
Each installment payment progressively secures the loan until it is repaid, at which point the borrower receives the loan principal.
In other words, each installment functions like a savings contribution as if it were part of a budget.
Many credit builder loans offer penalty-free cancellation, which means you can stop the agreement and recover the amount you've paid within 2 — 4 weeks.
This payout structure is unique to CBLs because conventional loans allow consumers to pay off the full value of the loan without penalty but do not allow cancellation.
The idea of a loan stresses some borrowers because it feels like work to go through the process and make monthly payments, as well as the mental energy associated with budgeting installments.
Most credit builder loan lenders provide an auto-pay feature to ensure minimal effort, but fully-secured CBLs go a step further. Some offers only require the borrower deposit funds up front, then handle all payments from the deposit account to the loan balance.
In other words, the money structure allows borrowers to "set it and forget it."
Consumers who set out to improve their profile quickly learn the complexity involved. Credit building requires careful planning and cannot be fixed overnight. Borrowers must consider previous credit marks, the amounts they can afford, and time each account to match with a major borrowing goal such as a home loan.
Credit builder loans provide an easy way to tackle multiple elements with one account because unlike credit cards they are installment debt that's inexpensive and easy to execute.
A major fear for many borrowers is making a careless mistake. Debt management is a complex field with niche specializations and industry-specific terms that even the most seasoned professionals must regularly revise.
From this complexity comes the risk of missing a payment, or worse, never knowing about it. Lenders have legal obligations to be transparent, but they often benefit when borrowers slip up.
Credit builder loans, however, are designed not only to provide banks with deposits they can use for other lending activity, but also as an opportunity to guide prospective customers from building to major borrowing. They are highly incentivized to make credit builder loan borrowers long-term customers.
The most important thing to take away from credit building benefits is that not all offers provide excellent terms. For example, some lenders do not offer penalty-free cancellation. Others may charge unreasonably high interest.
It's important consumers do their due diligence and lean on professional help or guided DIY plans to maximize return on their investment. After all, successfully choosing and using CBLs creates a desirable profile that landlords, insurance companies, and lenders look to for approval and rates.
Altogether, the consequences amount to $100,000+ on a single mortgage — and even more on auto, student, business, and credit card payments.
Noah Gomez (founder of Thick Credit) is a transatlantic professional and entrepreneur with 3+ years experience in consumer finance education. He also has 5+ years of experience in corporate finance, including debt financing, M&A, listing preparation, US GAAP and IFRS.
Thick Credit is not a credit repair organization, a credit conseling agency, or a debtor education providor. It does not act on your behalf to communicate with credit reporting agencies or provide pre-bankruptcy credit counseling and pre-discharge debtor education for bankruptcy.
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