Credit building loans are great because they allow you to build your credit without making any payments. However, most Canadians aren’t aware of how these loans work. As a result, many people who apply for them end up with bad credit.
Most Canadians don’t realize that credit building loans are available in Canada. They also don’t understand why they should even consider applying for one. But once you learn about them, you’ll see that they offer many benefits over traditional unsecured personal lines of credit.
In this post, we will explain everything you need to know about credit-building loans to decide whether or not you should apply for one.
What is a Credit Builder Loan?
Payments on a credit-builder loan are reported to a credit reporting agency (Experian) and may help establish a credit score. If you check your credit every month while paying your credit builder loan, you can be confident that your positive payment history is being recorded correctly.
Since payment history is the single most crucial factor in your credit score, you must keep making on-time payments on your loans to help build up a good credit score over time. On that same note, you should avoid making late payments since this may have the opposite effect and hurt your credit score even more. Payment more than 30 days late will also show up on your credit report and could damage your score significantly. While this may be a successful way of building credit, it may also backfire and further hurt your credit score if you cannot make the payments in time.
Best Place to Get Credit Building Loans in Canada
- Loans Canada
- Refresh Financial
How Do Credit Building Loans Work?
Once approved for a credit-builder loan, a loan officer opens a savings account, and you begin making monthly payments. In other cases, you will get your borrowed funds immediately – but will have to put down a certain amount of the borrowed amount into a savings account, which serves as your credit builder loan deposit. These types of loans incentivize you to save while building credit because, in the end, you end up with a nest egg in your bank account after paying off the loan amount and getting access to the borrowed funds. Think of a credit-building loan like a savings account, but instead of earning cash over time, you are paying a bank to build up your credit score.
You can access the money anytime, and payments are reported to credit bureaus — helping to build your credit file and enabling you to qualify for better loans over time. A certificate of the deposit secures your loan until you repay, it and your payments are reported to three major credit bureaus. Self says Self will report your payment history each month to all three major consumer credit bureaus.
Your deposits serve as collateral, and as you make payments on purchases, you build or restore credit on the Secured Card. In this scenario, a deposit you already hold with a financial institution is your collateral. This money is frozen until you repay your loan (or can gradually thaw as the loan is paid back). With a secured card, you typically deposit an amount equal to the credit limit into a particular security deposit account with your lender to protect or guarantee the loan. Funds Access: Any funds you cannot access right away are held in a fee-bearing account until you have paid the entire amount, just like with other loan-building loans that we have covered.
What Are the Requirements?
You also do not want to apply for too many new loans or credit cards all at once because that results in too many inquiries on your credit report – which also will bring down your score. Too many credit checks may signal to lenders that you are in a desperate financial situation and may reduce your chances of getting approved. Because lenders depend on your credit score to decide whether or not you will repay the debt, your damaged credit or no credit can limit your options and make it harder for you to get approved. Falling behind on payments on other loans or maxing out credit cards could damage your credit score, even if you are paying off savings loans diligently.
You generally cannot access the amount you borrowed until you are completely paid off your loan, meaning that you are building savings and credit simultaneously. Instead of getting the cash up front, your lender deposits the loan amount–typically $300 to $1,000, according to the Consumer Financial Protection Bureau–into a savings account or CD, which you cannot access until you pay off your loan. Specialty loan programs for building credit, offered by credit unions and smaller banks, include getting a savings account holding the loan amount.
Who Should (and Shouldn’t) Get a Credit Building Loan
A credit-builder loan can be a good match if you do not have anyone willing to let you be an authorized user on their account or you cannot qualify for a credit-building credit card. Taking out a credit-builder loan and paying for it over time may be one way to help you establish positive credit, which will lead to a stronger credit profile. Credit-builder loans have an undeniable benefit, as they can help you select a positive payment history where you may not have been able to do so otherwise. Depending on the lender, you can be eligible for a personal loan even if you do not have a good credit score or have a low score.
Some personal loans, such as payday loans, carry unique risks and will not likely help you build credit. If you are trying to make credit and need loan proceeds immediately (for debt consolidation, for instance), then an unsecured personal loan is likely your best option. On the other hand, if you choose to get a loan for building credit, you will want to ensure you can repay your loan fully and on time.
Thinking About a Credit Building Loan?
Remember that money you are paying toward a credit building loan is not available to you until your loan term is over. If there is a financial emergency, you can take advantage of the money instead of taking out another loan–a reliable way to ensure that your improved credit scores will continue to look great. Many banks will not offer this form of credit, and most credit unions will require you to have an account with them for several months before considering you qualified. This can also impact your application for apartments or even the telephone services you desire since they usually run a credit check before approving you.
Like other loans, loan construction with a credit score comes with costs: You will pay interest for the duration of your loan, although some lenders might refund some of your costs once the loan is paid off.