Life isn't always plain sailing. With bumps and trips in the road, our journey's may not be quite what we had planned, and there is barely any easy start. The journey of our credit score is no different. It's hard to start with no credit history at all, and even when we get going sometimes, there can be things that cause setbacks. Understanding how your credit score is calculated can go some way to helping you start this journey with ease, or maybe recover yourself if things go wrong. Credit building loans and credit builder cards are 2 of the options available to help you on your way. Don't know what these are or how they work? Have no fear, as we're about to tell you more.
Maybe you've just turned 18 and have no credit history. You've just been rejected for your first loan application, and you're not too sure why. Perhaps you're slightly longer in the tooth and your score is not the greatest. In the first case, you are starting from scratch with no credit history and nothing to show lenders that you're reliable and that they can trust you to repay. In the second, perhaps you have had some blips, and you have somehow damaged your credit score. Either way, you need to do some work to build your credit score and get to a stage where lenders will view you favourably. This is where credit building loans could come in.
Credit building loans are exactly what they say they are: they are loans that have been designed to build your credit. Sound good? But if you've already been declined for one loan, the last you thing you want to be doing is applying for numerous ones. So what makes these loans different?
Offered by companies such as Loqbox, these loans work differently from a traditional loan. With a traditional lender, you may, for example, borrow £1000. You will get £1000 into your bank account, and then you start making monthly repayments to the lender. You would, of course, pay interest on the loan and pay back more than you actually borrowed. At the end of the term, you'd have had use of the £1000 when you needed it, and you will have repaid the lender the £1000, plus interest. Credit building loans work a little differently.
With a credit building loan, you're not getting a loan as such. Sound confusing? Bear with us. With these companies, you agree to an amount that you can comfortably save each month. This could be £20, or it could be £200. Whatever amount you settle on, you commit to paying this to the credit building loan company every month for the next 12 months.
Once you commit to an amount, the credit building loan company will take your monthly amount and times it by 12 before locking that amount away for you. So, if you committed to pay £20 a month, there would be £240 locked away on your behalf. Each of your monthly payments goes towards this amount, and the lender reports each of your monthly payments to the credit reference agencies. The credit reference agencies see you consistently making payments, and this should then have a positive impact on your credit score.
At the end of the 12 months, you have 2 choices. Having effectively been saving for a year, you can have all of the money paid out to you with it being deposited into a new bank account for free. This is an account that the credit building loan company partners with. The other option is to have the funds deposited into an existing account, but you would pay a fee for this.
Credit building loans are a way to work towards raising your credit score. They have their benefits but also have their not so good points.
The not so good
One key point here is that yes these payments are reported to credit reference agencies, and so should improve your credit score, but the same applies to any loan from any provider. The credit reference agencies do not record the purpose of your loan, so any other lender who performs a credit check will simply see that you have a loan. They will not know whether you have taken this to rebuild your credit or any other purpose.
Credit builder cards are an alternative to credit building loans and will have the same desired effect: improving your credit score. These cards are great options for people who need some assistance to boost their credit scores. Offered by companies such as Vanquis, Aqua, and Capital One, they offer lower credit limits than mainstream credit cards and will typically also charge a much higher interest rate.
None of us wants to be paying higher interest rates, so what's the point you may ask. Well, taking out one of these credit builder cards and managing it well, will see you paying lower interest rates in the future. How? By improving your credit score and allowing you access to other credit at better rates.
To avoid the high-interest rates that we have mentioned, you can simply pay off your balance in full each month. The key here is not to use credit builder cards to splurge on treats. The best way to use them is to only pay for something that you ordinarily would, and have already budgeted for. For example, let's say that you spend £100 a month on fuel to get to work. This £100 is already part of your household budget so you usually pay it anyway. By using your credit builder card to pay for the fuel, you already have the £100. Instead of using the money you have for the fuel, you simply use it to pay off your credit card balance and avoid any interest.
By doing what is described above, you are showing the credit reference agencies and other lenders, that you are responsible with your lines of credit and can easily manage them. If you are maxing out your card and then paying the minimum payment each month that may set alarm bells ringing.
As we've seen, credit building loans have their advantages, but there are certain strings attached, and you're not actually getting a loan as such. These loans will increase your credit score, and they will allow you to build healthy financial habits such as saving, but they are not necessarily the best way to improve your credit score.
The type of credit that you're getting with credit-builder cards is known as 'revolving credit'. This means that you have the option to repeatedly borrow money each month, up to a set limit. This is a much better way of building your credit score; you are showing lenders that you have constant access to credit but that you still manage this responsibly by paying on time and not utilising the full available amount.
Yes, and it is only right that we save the best for last. At Wollit, you can easily build your credit score with all 3 UK credit reference agencies every month. It is all automatic, so you don't have to move a finger. Compared to credit building loans or credit cards, signing up only takes a minute, there's no paperwork, and we guarantee that we'll approve your application within seconds. We also don't perform any credit checks, so you don't have to worry about any damage to your file! Get started now!