How does a credit-builder loan work?

A credit-builder loan works like a normal loan but in reverse. With a credit-builder loan, the lender puts money into a savings account for you, you make fixed monthly payments totaling the amount in the account plus interest, and then you get the money in the account once you make all the payments. You can see the full step-by-step process of how a credit-builder loan works below.

How a Credit-Builder Loan Works

1. The lender opens a savings account. After the lender approves your application, they set aside a about $300 - $1,000 in a savings account for you. But you won’t have access to the money until you pay off the loan, plus interest.
2. You make payments. You will make equal monthly installment payments to the lender over 6 to 24 months, depending on the size of the loan and the lender’s policies.
3. The lender reports your payments to the credit bureaus. The lender will report your payment status, whether on-time or late, to the credit bureaus each month. If you pay on time, your score should increase. If not, your score will decrease, which defeats the purpose of getting a credit-builder loan.
4. The lender charges interest. APRs tend to range between 6% and 16%. The cost of this APR may be slightly reduced by the interest you earn on the savings account, if the lender puts your money in an interest-bearing account. In addition, the lender may return some of the interest you pay on the loan at the end.
5. You receive the funds. The lender will give you the money in the account once the loan term ends. You will be free to use the funds for whatever you wish.

To learn more, check out WalletHub’s guide to credit-builder loans.