What Are Credit Rebuilding Loans?

Written By Cathy Lovering
Last updated June 15, 2021

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Credit
June 15, 2021

Simple. Thrifty. Living.

Your credit history is an important part of your financial life. So what happens when a few missteps make it hard for you to get new credit? You do have options for financial products to help improve your credit rating. Credit rebuilding loans are one such product. They help people with no credit history — or poor credit history — to demonstrate their financial worthiness to potential lenders.

Credit rebuilding loans don’t work like traditional loans. Not all banks offer them. You usually don’t get the loan amount until you have made all the payments. The upside is that regular, on-time payments can give you a positive credit history, which is essential when you’re trying to improve your credit score.

Credit rebuilding loans work a bit like traditional loans in reverse. The lender agrees to a set loan amount. They do not give you this amount upfront. Instead, they put it aside in an account you can’t access. You make payments according to the terms of the loan, usually for 6 to 24 months. At the end of the term, you receive the full amount of the loan.

Some lenders work on a slightly different model. Differences might include:

  • Paying you interest on the loan amount at the end of the term, along with the principal.
  • Issuing you some of the loan principal during the term, in the form of installments.
  • Creating a “share” or “certificate” backed loan, where the money you already have on deposit with the bank or credit union is held as security. With this type of loan, you get the amount you borrow at the start of the term, but you can’t access the security funds until you pay off the loan.

Credit rebuilding loans are often called “credit-builder loans,” or “secured loans,” depending on the lender. Community banks, credit unions, and sometimes larger financial institutions offer these products. They are not always advertised, so if you are interested ,you can ask your bank.

The real benefit of a credit rebuilding loan is that banks report your payments to credit agencies. That means they help you build a history of on-time payments, just like a regular loan. The flip side is that your bank also reports any late or missed payments So if your credit history is already imperfect, a rebuilding loan only helps if you know you can make the payments in full and on time.

A lender may or may not perform a credit check for a rebuilding loan. They may ask for other information about your financial status, including:

  • Income amount.
  • Employment status.
  • Housing costs.
  • Outstanding loan or credit card balances.
  • Bank account balances.

It’s also possible they ask for personal references before they approve the loan.

Lenders usually want documents to back up the information you provide. So expect to give proof of income, employment, and bank accounts. If you are dealing with your own credit union or community bank, they may already have this information on file.

There are a number of potential benefits of a credit rebuilding loan, as well as some potential downsides. Consider these before signing on with a bank.

Pros:

  • Banks are more willing to extend this type of loan to people with no or poor credit.
  • Lenders report on-time payments, demonstrating your creditworthiness.
  • Since the bank holds the funds, there’s no risk of spending all the loan proceeds while you make monthly payments.
  • At the end of the term, you have no more monthly payments and you get the loan amount to you in one lump sum.

Cons:

  • You have to make room in your budget for an “extra” payment.
  • Lenders report missed payments, which go on your credit history.
  • It is impossible for you to access your security funds or the loan principal during the term.
  • Not all banks offer credit rebuilding loans so it may be hard to find a lender.

This type of loan is a commitment to make on-time payments for a set period. It’s smart to consider what you can actually afford. Most credit rebuilding loans are in increments of $300 to $1,000. Before applying, try to set aside the amount of a monthly payment for a few months. That way, you can see if your budget can handle the loan — before the payments affect your credit rating.

A credit rebuilding loan is just one way to improve your credit rating. Here are some other ways to do so:

  • Check your credit report for free at AnnualCreditReport.com
  • Ask reporting agencies to fix credit report errors.
  • Pay your bills on time to improve your payment history.
  • Pay down debts to increase your credit utilization ratio.
  • Consider a secured credit card.

The last option, a secured credit card, is an alternative to a credit rebuilding loan. With this kind of card, you put down a security amount that the bank refunds to you when you close the account. The amount of credit on the card is usually equal to the amount of the security deposit. Payment history goes on your credit report just like a regular credit card.

A secured credit card offers convenience, as it works the same as a non-secured credit card. Some lenders may upgrade your card and no longer require security after a period of on-time payments. Unlike a credit rebuilding loan, a secured credit card does not work to help you build up savings.

Many people feel stuck if credit challenges hold them back. The key is to remember you have options. You can make choices that repair your credit history. A credit rebuilding loan helps you to put money aside for a rainy day, while showing potential lenders that you can make on-time payments. This can also help you develop a good relationship with your community bank or credit union, which can be your financial partner for years to come.

About the Author

Cathy Lovering

Catherine Lovering has written about personal finance and health for over 10 years, with bylines on IvyExec.com and Healthline.com. She holds an LL.B. (J.D.) from the University of Victoria.

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