How to use a credit builder loan to improve your credit score
A credit builder loan helps those with poor credit scores or limited credit history demonstrate creditworthiness. Borrowers agree to fixed monthly payments and receive the money once the loan is repaid. Think of a credit builder loan as a savings account that's reported to a credit reference agency.
If you have a poor credit score, or a “thin” credit file, as the result of not having borrowed much money in the past, or perhaps because you have recently moved to the UK from abroad, it can be a challenge to take out a loan. Many lenders will not accept applications from those with poor credit scores.
» MORE: How to check your credit score
This can leave you in a difficult 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 know how to handle credit well and have repaid loans regularly and promptly.
This is where credit-building loans come in.
A few specialised lenders offer loans to those with poor credit scores or thin credit files to help improve your score and make it easier for you to borrow in the future. Those lenders include online loan companies, credit unions and community lending schemes.
Credit builder loans
Credit builder or credit repair loans operate differently to conventional personal loans, in fact they are structured more like savings accounts.
You agree to borrow a set sum, but you cannot access the loan until it is fully paid for. Instead you send the lender pre-agreed monthly repayments. At the end of the term, the money is released.
The benefit is that each month’s repayment is reported to the credit reference agencies.
The downside is that you are paying what can end up being a high interest rate for an alternative way of saving money.
If you pay in full and on time, your credit report will improve and hopefully, at the end of the term of the loan, you will not only have a sum of money that you could use as an emergency savings fund or for something else, but you should have improved your ability to borrow from mainstream lenders, too. This should be more affordable and avoid the need to take out subprime loans or high-cost credit.
If you opt for a credit builder loan it is vital that you sign up for repayments that you can realistically afford. If you miss a payment it will be reported to the credit reference agencies and further damage your score, undermining any benefit of this type of loan.
It depends on the lender but you can usually borrow from about £500 to £5,000 over a period 12 to 36 months, but watch out for interest rates on these loans, and understand how much it will cost you over the term of the agreement.
» COMPARE: Loans for bad credit
Also know that there may be cheaper, and free ways to improve or rebuild your credit file.
Credit builder credit cards
Credit builder credit cards offer a way to improve your credit score by showing that you can clear them on time and can handle being in debt. They are preferable to a credit builder loan if you need to pay for something straight away, and they can end up being cheaper if you clear the balance in full each month.
Credit builder cards can come with enormous APRs, and can trap you in a spiral of debt if you borrow more than you can afford and cannot meet repayments.
Other ways to improve your credit score
You can do free things to try and improve your credit score, and you might want to hold off applying for a loan until you have tried them all.
Make sure you are on the electoral register, make sure there are no mistakes on your credit file, if there are you can add a notice of correction, and you could consider adding your rent, or household bills through credit reference agencies such as Experian.
There are more tips on how to get your credit files into the best shape possible in this guide.
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Laura is a journalist and author, writing about money since 2008. Including writing for The Times for 9 years. She believes finance doesn't need to be complicated. Author of Money: a user's guide. Read more