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Want to buy your way into a better credit score?
Some banks are happy to oblige. A new product offered at many regional banks and credit unions allows customers to pay up to improve their FICO credit score.
Meet the credit builder loan
Credit builder loans are fairly new, and many more banks offer them today than ever before. A credit builder loan is a low-interest loan designed for the purpose of helping you build positive credit history.
Here's how they work:
- A customer agrees to borrow a small amount of money, often $500 to $2,500.
- When the loan is issued, the funds aren't turned over to the customer. Instead, the loan amount is placed in a savings account or certificate of deposit.
- Over the next six to 18 months, the customer makes routine monthly payments (including interest) until the loan is paid off.
- The funds, stored in a CD or savings account, are turned over to the borrower only when the loan is paid in full.
A banker's dream
Credit builder loans are a (small) goldmine for banks. The loans carry absolutely no risk for banks and credit unions, since the loan proceeds are not disbursed to the customer until the loan is paid off.
I searched the Internet and phoned up a few banks to find the typical repayment terms on a credit builder loan (sometimes referred to as a "starter loan.")
Here are a select few options:
| Bank or credit union | Interest rate (APR) | Total interest on a $1,000 loan |
|---|---|---|
| Credit Union A | 3.11% | $16.93 |
| Credit Union B | 5% | $27.29 |
| Regional Bank A | 12.897% | $71.23 |
| Community Bank A | 3% (+ $50 fee) | $67.14 |
| Average | 9.8% including fees | $45.64 |
Should you do it?
So you know how it works. You know what credit builder loans cost (anywhere from $17-$67). But should you take out a credit builder loan just to build credit?
The answer is maybe.
First, know that there are better alternatives. A no-fee credit card -- secured or unsecured -- is your best shot at getting a positive account on your credit report. And it won't cost you a dime, assuming you pay it off in full each month.
Failing that option, a credit builder loan in the smallest loan amount possible (why pay more interest than necessary?) from a local credit union (which seem to have to lowest-cost loans) can help you repair your credit with minimal cost to you.
Sure, you'll be paying for the privilege of a better credit score. But in the worst case scenario, credit builder loans offer an opportunity to get on the good side of a bank at the price of dinner for two.
