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To boost folks' credit scores, a financial product called a credit-builder loan provides a loan of cash that borrowers can't spend, which is paid off a bit each month. The primary effect (and benefit) of the loan is that that the borrower's credit score goes up.

Some loans, across a variety of types including mortgages, home equity loans, car loans, and even credit cards, have restrictions on what you can use the proceeds of the loan for, and there are restrictions or different terms if you want to get cash out for more flexible use. Restrictions that apply to credit-builder loans seem to fit into that context; they're just tighter.

However, a prospective traditional lender looking at a credit history or score trying to decide whether or not to give a loan to a new person, wants to know something about that person's likelihood to repay when there aren't as many restrictions. Success with a credit-builder loan seems to indicate primarily (a) consistent identity and (b) that the person would like to increase their credit score, but it does not necessarily signal the kinds of things application-reviewers are really trying to assess (e.g. likelihood of repayment of a new loan).

Credit reports also differentiate between different types of loans (e.g. mortgage vs. car loan vs. credit card) and scores tend to increase when a person has multiple accounts and a mix of account types.

How do credit-builder loans show up on credit reports and factor in to credit scores?

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    Do you need to pay someone to improve your credit? For most people, this product is trading on Fear, Uncertainty, and Doubt (FUD) rather than addressing a genuine need. – keshlam Jul 16 '16 at 23:07
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    This is the first I've heard of this, so I have no definite answer. In the long run (if not also the short run) the industry is going to catch on to this and flag these loans like education and employers are increasingly flagging resumes with for-profit education on them. I would speculate that having such a loan will actually lower your score when/if that happens. – user32479 Jul 16 '16 at 23:55
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It should probably show up as an installment loan (retail agreement). It isn't technically secured, because you aren't putting up any security. With SelfLender, they open a CD for $1,100 and you make the 12 monthly payments of $97. The CD is only yours if you make all of the payments as agreed.

Such loans are important, because they show your ability to make a year's worth of payments responsibly. The real effect on your credit score doesn't happen until you're about six months into the payments and have a reasonable track record. You will see some small bump when the account is first reported, but the larger bump will happen once you've established you are making the payments.

The thing about companies like SelfLender, if I can throw a bit of a damper on things, is that they're actually betting against you. All you have to do is figure the math to understand that. 12 monthly payments of $97 equals $1,164. The CD they're setting up for you is for $1,100 plus 0.10% interest. So if you successfully pay off the "loan", SelfLender actually makes no money at all. On the other hand, if you miss payments, you've defaulted on the loan, in which case the CD is cancelled and SelfLender keeps the sum of whatever payments you did make. That's the only way they make any money on the deal. So they're counting on you defaulting. As much as you think they're rooting for your success, the opposite is true.

I hope this helps.

Good luck!

  • This answer currently says, "It isn't technically secured." Isn't it secured by the money in the CD or other account, that you can't touch until everything's paid? Also, with the $12 up front fee it works out to be like $98/mo and they make $76/customer on that. – WBT Jul 17 '16 at 3:17
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    No, it isn't secured, because it isn't your money they're holding. They set up a CD with their own money, which they keep anyway of you don't pay. A secured account is one in which you put up the money as collateral against a line of credit they give you, and if you don't pay they confiscate it. As for their $76 per customer margin, much of that is eaten up in costs and overhead. There's no profit in customers who pay all 12 payments. The real money is when someone gets six or more months in and defaults. THAT'S their real profit. – Daniel Anderson Jul 17 '16 at 3:54
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    Even if you assume the $76 per customer is all profit, that's still just a return for them of around 6%, which is not enough to justify it if that was all they were to make. I guarantee you they are banking on a high default rate. If just 10% of their customers default after six months of payments, their rate of return is about 18%, and that is well worth the effort and investment. – Daniel Anderson Jul 17 '16 at 4:10
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    First, the 12.65% is the interest rate you're paying on the loan over its lifetime, if you pay it all. That isn't what they earn. You have to remember they're giving you $1,101.10. Your total of payments would be $1,176 ($97/mo. plus $12 app fee). I've worked in finance, and I promise you that their default rates are well north of 10%, just by the nature of the market they're in. That's where their money really comes from. For them, encumbering $1100 for a year for only a $75 gross return doesn't make sense unless there's a more lucrative way to profit -- defaults. – Daniel Anderson Jul 17 '16 at 12:00
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    You're correct on that point, but as a bank, do you really think they'd not be able to find something more lucrative than T-bills? Any time you start extending credit regardless of credit score, as SelfLender does, the default rates are always in the double digits. The average national default rate on loans runs between 2.5% and 3.75%, depending on whose numbers you look at. SelfLender borrowers are not in the average, or else they wouldn't need such loans. Even using the 2.5% average, SelfLender makes far more money if you default than if you pay in full. – Daniel Anderson Jul 18 '16 at 10:49
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My understanding is that 'credit builder' products Loans, credit cards etc dont improve your score if you have them as such, the have higher interest rates than regular bank loans and other cheaper forms of credit.

They are more likely to lend to you than regular banks and cheaper sources of credit. But if you can manage these loans correctly by making the payments every month it show on your credit report that you are capable of making payments and managing your finances.

Different credit agencies look at your credit report and apply different criteria to it- the score is just a guideline

  • The whole point of these products is that they do improve your score, and interest rates on loans are consequence rather than cause of credit score/record. – WBT Jul 16 '16 at 18:56
  • Simply obtaining a credit builder product does not improve your credit score, your score improves by you proving you are able re-pay and manage credit. The call it 'Credit Builder' as a marketing strategy and aim it at people who want to improve their rating, generally because they have been rejected for credit on the basis of a bad credit score- you are more likely to be accepted for a credit builder loan than a another loan. This is because they trust you less and therefore charge more in interest and fees – Kurt Money Jul 16 '16 at 19:52
  • This still fails to answer the question about how such products are shown on credit reports and in credit scores. – WBT Jul 16 '16 at 20:19
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    They are shown the same way as a regular loan product- it will show on your credit report how much you have borrowed and if you are making the repayments on time – Kurt Money Jul 18 '16 at 20:43

protected by Community Jul 31 '16 at 20:56

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