What is a rebuilder loan? No, it’s not a construction loan. Or then again, maybe it is, as in “re-constructing” your credit.
Many consumers find themselves at the stage where they are coming out of a period of unmanageable debt, now have their finances under control, and want to prepare for the future when credit might be needed for a new home or car, or even just a good rewards card with a high limit.
While there is no standard definition of credit “rebuilding,” a typical consumer in the rebuilding — or re-establishing — phase can be expected to have a FICO score below 650 or so. And when talking about rebuilding credit, we’re generally talking about the “two-pronged” approach of proactively adding positive credit history while allowing the negatives to sink further into the past.
For the part of the rebuilding equation where we want to add new positive history, the Catch 22 arises in that you have to have good credit to get new credit at reasonable rates. So the difficulty for consumers with low credit scores then becomes finding an affordable credit rebuilding product for their own situation.
[Related Article: The First Thing To Do Before Applying For a Credit Card]
One of the great solutions to this dilemma has been, and continues to be, the secured credit card. For pure credit rebuilding purposes, it remains the most flexible tool for low scoring consumers in terms of positive score impact and low cost. But credit cards — secured or unsecured — are not for everyone. Whether it’s the lack of savings, temptation to charge presented by any credit card, or simply a preference for the predictability of an installment loan over a credit card account, for some people a personal loan is the most practical way to add positive credit history to an otherwise dismal credit report.
The two major categories of personal loans are secured and unsecured, with each providing equal credit score-rebuilding opportunities when reported to the credit bureaus.
Unsecured personal loans have been available to consumers since just about the beginning of time. And as no surprise, the best rates for these loans go to borrowers with the best credit ratings, so rebuilders can expect to pay high interest rates when going the unsecured personal loan route. Nevertheless, these loans, when reported to the credit bureaus, can help raise a low credit score by adding positive account history, just like a mortgage, auto or student loan.
[Credit Score Tool: Get your free credit score and report card from Credit.com]
A cheaper loan
One rather creative way of minimizing the interest expense of an unsecured personal loan — assuming the lender’s repayment terms will allow it — is to make larger-than-minimum monthly payments early on in the life of the loan to significantly reduce the balance, and thus the interest paid. Then, instead of paying the loan off early, which is not quite as good for the rebuilding process as keeping it open and active, make small monthly payments during the latter months to keep the loan open until end of the established term. This way, you reap the benefits of a positive account history for as long as possible, while minimizing the overall cost of the loan. But again, this method is only possible if the lender allows a borrower to “pay ahead” through larger-than-minimum payments.
For rebuilders who prefer loans over credit cards, and have been able to put away some savings for collateral, a secured personal loan reported to the credit bureaus will provide the same score-rebuilding benefits as an unsecured loan, but at much lower interest rates. Credit unions tend to be a good resource for secured personal loans.
When rebuilding credit is the goal, a personal loan paid on time each month can go a long way toward showing future lenders that a consumer’s credit troubles are behind her and that she’s now back to managing her credit responsibly — and with a good score to prove it.
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Image: Hey Paul, via Flickr