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Loans: A Tool to Fight Poverty?

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You need to use credit to build good credit, but it’s difficult to get credit without a credit history — it’s a Catch-22 that frustrates consumers everywhere. It can be especially troubling for people with low incomes, who have few loan options when they’re in a bind. As a result, they often turn to high-risk products like payday loans, which will likely hurt their credit in the long run.

It’s a problem they’re trying to tackle at the Local Initiatives Support Corp., a community-development organization that offers credit-building loans to low-and moderate-income consumers through a program called Twin Accounts. The accounts are available through LISC Financial Opportunity Centers located in Illinois, Michigan, Minnesota, Ohio and Texas.

The program was outlined recently in the New York Times Magazine: Participants start off by taking on a $300, 12-month loan. It sounds counterintuitive — putting poor people in debt to improve their credit — but the accounts can be very valuable for people who have struggled to break into the credit world.

How it works: The participants take out the loan, but they don’t get access to the money immediately. That $300 goes into a “locked” savings account held by Justine Petersen Housing & Reinvestment Corp., a financial partner of LISC, and the borrowers make monthly payments at a 9% fixed interest rate until the loan is repaid. The master savings account has subaccounts in the borrowers’ names, Justine Peterson reports the payments to the credit bureaus, and for every on-time monthly payment (about $26), LISC matches the amount paid. By the end of the loan term, the accountholder has built 12 months of strong payment history and put $600 in a savings account.

The participant gets an account by agreeing to continue building credit after the loan is paid, saying they’ll use at least $300 of the money saved to open a secured credit card and continue exercising smart financial behaviors. The ultimate goal is for the person to build their previously nonexistent credit to the point where they can get a traditional credit card on their own.

According to LISC’s website, accountholders who came in with no credit score earned a 676 FICO score after six months of timely debt repayment. The site says the 82% of the program’s 220 participants have paid off the loan in full, and two-thirds have made all their payments on time.

Considering that payment history has the largest impact on your credit scores, that’s a good development for people who struggled to get credit before getting a Twin Account.

As far as what happens to the program participants who aren’t making on-time payments, it’s unclear what happens to the $300 loan, but it’s likely their failure to make loan payments creates a negative credit history. It calls into question whether or not it’s a good idea to start these people out on credit by handing them unusable debt, but the seemingly high success rate is also promising.

If You’re working on building your own credit profile, the Credit Report Card is a free tool that can help you track your progress. The Report Card updates two of your credit scores for free every month, as well as evaluating your credit strengths and weaknesses.

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