What Is a Credit Builder Loan? How can you build your credit by taking it?

Creditworthiness is the most vital aspect when it comes to financing. Whether you apply for a personal loan or a car loan or a home loan or a credit card, the lender checks your credit score to determine your eligibility for the loan. A high credit score assures the lender that you are a responsible borrower and the lender feels more open to offer you the loan. But, if you have a poor credit score, there is a higher chance of the lender denying your loan application. A poor credit score can be either due to poor financial behaviour or a mistake made by your previous lender. In this situation, a Credit Builder Loan can come to your aid.
 

What is a Credit Builder Loan?

 
A credit builder loan in India is designed to assist individuals with poor or no credit history in building a solid credit profile from scratch and preparing themselves for substantial funding in future. This loan product is ideal for first-time borrowers or those who have failed to repay previous debts due to a financial crisis such as job loss or a medical emergency.
 
Credit builder loans are distinct from regular loans in terms of disbursement. Here, the lender does not release the funds immediately after approval; instead they release the funds after a few months of paying interests.
 

How does Credit Builder Loan work?

 
In the credit builder loan, the lender does not disburse funds in the beginning. Instead, the following procedure is used.
 

• Opening of saving account

  The lender opens a saving account on your behalf or sometimes a certificate of deposit (CD). Depending on the account type, you might earn interest on it. 
   

• Interest payment

  Even though the funds are not disbursed immediately, the lender charges an annual percentage rate (APR) on the loan amount. The rate can range between 6% and 16% and is predetermined based on the risk associated with your profile. You are then required to pay a fixed EMI comprising interest and principal amount. 
   

• Reporting

  The lender of a credit builder loan sends regular updates to the credit bureau about your repayment. Payment of EMIs on time will help to improve your credibility, whereas missing just one EMI will nullify all your efforts.
   

• Disbursement

  After you have made regular payments for the required number of months, the lender will release the funds for you to withdraw and use as you see fit. The available funds include the interest you have paid to date after deducting the loan fees.
   

Also Read: What Life Goals can you Achieve after using Personal Loan
 

What are the Benefits of a Credit Builder Loan?

 

• Easy access to funds

  You cannot obtain funds from any lender if you have a poor credit profile. In such cases, a credit loan provides you with a line of credit to help you meet your financial needs while also improving your credit score.

• Improves borrowing potential

  A credit builder loan allows you to improve your credit and qualify for larger loans in the future. With the help of this loan, you may be able to secure a large sum through a loan against property.
   

What are Some Tried and Tested Ways for Increasing One's Credit Score?

• Regular repayment

  Instead of paying EMIs for credit builder loans, it is best to plan your finances so that repayment is not difficult. Always automate your EMIs and other vital and recurring expenses.
   

• Higher credit limit

  Revolving financing is a common loan product. However, using more than 30% of the total limit on a regular basis will only lower your score. In this case, requesting a higher credit card limit makes sense.
   

• Credit mix

  Never weigh your portfolio with a single type of product. For example, if your debt portfolio only consists of unsecured loans such as personal or term business loans, your credibility will suffer. However, if it is a mix of unsecured and secured debt products, expect a 5-10% increase in score, with other parameters also favouring you.
   

• Dispute errors

  If you notice any inaccuracies on your credit report, such as the display of a closed loan account as an open one or EMI skips that you have already paid on time, you must report it to the credit bureau agency right away.
   

Why is a Credit Builder Loan not Always a Good Idea?

 
Credit builder loans are not prevalent in India. So, the competition is low and so are the features. Furthermore, in case you require immediate funding, this loan product is not ideal. The reason is lenders only make disbursements after several months of successful EMI payments.
 
Alternatives to credit builder loans include applying for a personal loan with a co-applicant or pledging valuables as collateral.
 
Also Read: Can A Personal Loan Help You Improve Your Credit Score?
 

Conclusion

 
A credit builder loan is an effective strategy for those who have a poor credit profile and are facing trouble obtaining a new loan. However, not every financial institution offers this loan. Moreover, if you are in immediate need of money, obtaining a personal loan with a co-applicant or pledging your assets against your loan is a much better option.