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If you have a poor credit score, or not much credit history, also known as a ‘thin’ credit file, could a credit builder loan help you?
Many lenders won’t accept applications from those with poor credit scores or limited credit histories because they are seen to be a greater risk than someone with a good credit score. That perceived risk is mainly because there isn’t a history or evidence of repaying loans on time.
This can leave you in a chicken and egg situation — you need a better credit score to borrow, but your credit score won’t improve unless you borrow money. Lenders like to see that you can handle credit well and have repaid loans regularly and promptly.
This is where credit-building loans come in. But be aware borrowing when you have a bad credit score will usually be more expensive and may not always be the best idea. You should only apply for credit if you are confident you will be accepted, or you may do more harm to your credit score.
What is a credit builder loan?
Credit builder, or credit repair, loans are designed to help those with a bad credit score or a limited credit history improve their score. By making all the repayments on a credit builder loan, you demonstrate that you can manage your finances and repay a loan in full.
These loans aim to help you rebuild your credit score, so if you need to borrow money in the future you can hopefully access more affordable rates.
Credit builder loans typically only offer a relatively small sum of money. The amount you can borrow varies between providers, but it can typically range from less than £100 to £5,000 or sometimes more, with repayment terms ranging from six months to several years.
But these loans can be very different to standard personal loans. Some lenders will “lock away” the money and only give you the money once you have made all the necessary payments.
You may also need to pay a fee to use a credit building product, which can make it an expensive way to build up your credit score.
Mainstream banks and lenders don’t typically offer these kinds of specialised loans, but a handful of specialist online providers and credit unions do. However, you may not always be eligible for a loan from these lenders.
» MORE: Credit union loans explained
How do credit builder loans work?
Credit builder loans often work differently from conventional personal loans.
When you apply for a credit builder loan, you agree to borrow a set sum of money and repay it in monthly instalments.
However, you may not always be able to access the money straight away. In these cases, you would send the lender agreed monthly repayments and the money is released to you at the end of the term. And in some cases a fee may be kept.
Not every credit builder loan works in this way, so check with the individual provider.
If you opt for a credit builder loan, it’s vital to make sure that you can realistically afford it. Providers will conduct credit checks and check your income and employment status to make sure you can afford the repayments.
As with any other loan, if you miss a payment the lender can report this to the credit reference agencies which could damage your score and undo the work you’ve put into improving it..
Who are credit builder loans for?
Credit builder loans are intended for people with bad credit scores or limited credit histories, such as young people who haven’t had time to build up a credit history.
These people may struggle to get accepted for a loan elsewhere or, if they are accepted, they may face high interest rates. Credit builder loans can help these individuals to improve their credit score and increase their chances of accessing credit in the future.
However, not everyone will qualify for credit builder loans. Providers set their own criteria, so you may only be able to get a credit builder loan if you’re a certain age, live in a certain area, or have a minimum income, for example.
In some cases, you may not be able to apply for a credit builder loan directly. Instead, a provider may direct you to their credit builder loan if you don’t qualify for their standard loan.
If you can’t find a credit builder loan that you are eligible for, there are other ways you can rebuild your credit history.
» MORE: Can I get a loan with no credit history?
Pros and cons of credit builder loans
Credit builder loans have several advantages including:
- Each month’s repayment is reported to credit reference agencies.
- Your credit score should improve if you pay each instalment on time and stay on top of any other payments.
- You may receive a sum of money that you can use as you wish (depending on the loan agreement of the provider, you may get this at the end of the term).
- Paying off the loan should improve your chances of accessing credit at more affordable rates in the future, rather than needing to take out high-cost credit from sub-prime lenders.
However, credit builder loans also have some disadvantages:
- You can only borrow a relatively small sum of money.
- In some cases, you will only receive the money once you have made all your repayments.
- They are only available from certain credit unions and other providers.
- Providers will set their own criteria, so you may not be eligible.
- You may need to pay a fee, which means it can be an expensive way to rebuild your credit score.
- Allowing time to pass since whatever damaged your credit score will also help improve it without the need for additional borrowing.
Is a credit builder loan a good idea?
Credit builder loans can be a good idea if you’re struggling to build up your credit history. They allow you to show you can make payments on time, which can help to improve your score.
But credit builder loans often come with a cost. There are cheaper ways to improve your credit score, so it may be worth exploring these methods before considering one of these loans.
Credit builder loans are also unlikely to be suitable if your main aim is to borrow money, rather than building up your credit score. You may not get the money immediately with a credit builder loan, so you may want to consider alternatives if you want the loan for a particular expense.
But bear in mind that, if you don’t have a good credit score, these alternatives may come with high interest rates and if you miss a payment, or your application is refused, this will harm your credit score.
Alternatives to credit builder loans
Credit builder credit cards
Credit builder credit cards offer a way to improve your credit score by showing that you can clear your debts on time and can manage your finances. The credit limit on these cards will often be lower than on standard credit cards.
It may be preferable to a credit builder loan if you need to pay for something straight away, and it can end up being cheaper if you clear the balance in full each month. Credit builder credit cards may also be more readily available than credit builder loans.
But bear in mind that applying for a credit builder card will involve a credit check that will appear on your credit file.
These cards may also charge higher rates of interest than standard credit cards, which makes it even more important to stay on top of your repayments, and ideally pay off your card in full, to avoid building up unmanageable debt.
Borrow from family or friends
If you need money to cover an immediate expense, a credit builder loan may not be much help if you can’t access the money straight away.
Instead, it may be worth asking your friends and family if they are able to lend you some money.
This can be a cheap way to borrow money and your poor credit history, or lack of history, won’t be an issue.
But this has its disadvantages too. It means that, when you pay back the money to your friend or family member, you won’t be able to build up your credit score. So if you want to borrow money again in the future, you still wouldn’t have a credit history to prove your reliability to lenders.
It’s also worth considering the impact that borrowing money from a loved one could have on your relationship, and any complications this may cause.
» MORE: Lending to friends and family
Improve your credit score
Credit builder loans can be a costly way to improve your credit score. There are several things you can do to boost your score for free, so it’s worth trying these before looking into a credit builder loan.
For example, you can make sure you are on the electoral register and that there are no mistakes on your credit file. If there are any mistakes, you should contact the credit reference agency to correct them.
You can also sign up for schemes that use information about your rent, bills, and other regular payments to calculate your credit score. So, if you make these payments on time, you show credit reference agencies and lenders that you can manage your finances, which could make lenders look more favourably on any applications you make.
» MORE: How to check your credit score
Get help with your debt
Speaking with a professional, whether that’s over the phone, in-person or online, can help ease the pressure of finding a solution to your debt problems.
Financial worries can significantly increase stress, so it’s important to take care of your mental health while dealing with debt.
You can get free help from a range of debt charities, such as StepChange, National Debtline and Citizens Advice. Mental health charities, such as Mind and Mental Health UK, can offer free advice and resources to help you cope with an extremely stressful situation.
Image source: Getty Images
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