A credit-builder loan is a unique type of loan that is specifically intended to help increase the user’s credit score. With a credit-builder loan, the “borrower” actually pays the lender in monthly installments and then receives the money in a savings account at the end. During the process, the lender reports the monthly payments to the credit bureaus, which builds the borrower’s credit history.
So, you can think of a credit-builder loan as a series of savings-account deposits that help improve your credit standing. The difference is you will owe the lender interest, and you may need to pay a fee to open an account. Nevertheless, a credit-builder loan can be a great choice for people with bad credit or no credit history.
In contrast, a regular loan gives you a lump sum of money upfront, and then you pay that money back over a specified period of time. Unlike most personal loans, credit-builder loans are open to people who have no credit or even bad credit. This is because the lender doesn’t have much risk since they hold the savings account until you finish paying.
Below, you’ll find a more in-depth explanation of how credit-builder loans work and how they compare to top credit-building alternatives.
Best Places Get a Credit-Builder Loan
Best Bank to Get a Credit-Builder Loan: Sunrise Banks
The best bank for a credit-builder loan is Sunrise Banks because it places the loan funds into an interest-bearing CD. This helps to reduce the cost of the loan because you’re earning money on the account at the same time. In addition, even though Sunrise Banks is a bank that’s local to Minnesota, people anywhere in the U.S. can apply online for a credit-builder loan.
Sunrise Banks also offers both 12-month and 18-month credit-builder loans. In each case, the monthly payment amounts to approximately $50, with an average APR of around 21% for the 12-month loan and 15% for the 18-month loan. The amount of interest you will earn on the CD can vary from person to person, and you’ll need to speak individually with a representative to find out more.
Best Credit Union to Get a Credit-Builder Loan: Alltru Credit Union
The best credit union to get a credit-builder loan from is Alltru Credit Union because you can get a refund for 50% of all of the interest you pay over the life of the loan. Plus, the APR is 12% to begin with, which is decently low. Alltru offers 12-month credit-builder loans of $300 to $1,000.
To get a credit-builder loan from Alltru Credit Union (formerly 1st Financial Credit Union), you will need to become a member. Membership is open to people who live in the City of St. Louis, St. Louis County, or St. Charles County. Relatives of existing members can also join.
Best Online Lender to Get a Credit-Builder Loan: Self
The best online lender to get a credit-builder loan from is Self (formerly Self Lender) because it offers loans with payments as small as $25 per month for 12 to 24 months. Self credit-builder loans are also available to people in all 50 states. The loans typically have an APR of around 15% with an administration fee of around $9.
No matter where you decide to get your credit-builder loan from, the lender ideally should report payments to all the major credit bureaus: Experian, Equifax and TransUnion. Sunrise Banks, Alltru Credit Union and Self report to all three major bureaus.
How Does a Credit-Builder Loan Work?
A credit-builder loan works the opposite way of a regular personal loan, but the start of the process is similar to how you’d go about getting a personal loan. First, you’ll need to compare lenders. When deciding which lender is best for you, it’s important to look at the loan amounts they offer, their APR range, their fees and whether the savings account is interest-bearing.
Next, you’ll submit an application. This process is very similar to applying for a normal personal loan. The application will include such things as your address, income, employment status and housing status. You may also need to provide proof of income, employment, existing bank accounts and more.
Before opening your credit-builder loan account, you may have to pay a small, one-time administration fee. Some lenders may also charge a fee for late payments.
A credit-builder loan really starts working differently from a personal loan after the borrower’s application is approved.
- The lender opens a savings account: After the lender approves your application, they set aside the amount of the loan in a savings account for you. But you will not have access to this account until you pay off the full loan amount plus interest.
- You make payments: You will make equal monthly installment payments to the lender over six to 24 months, depending on the size of the loan and the lender’s policies. Most credit-builder loans run from $300 to $1,000, according to Experian.
- 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 are responsible and pay on time, your score should increase. If not, your score will decrease, defeating the purpose of the loan.
- The lender charges interest: APRs tend to range between 6% and 16%. However, the cost of this APR may be slightly reduced by 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.
- You receive the funds: Once you have finished making all your payments on the loan, the lender will give you access to the savings account or wire the money to an account of your choosing. You will be free to use the funds for whatever you wish.
If you take out a credit-builder loan, it’s best to pay only what’s required of you every month. The whole point of a credit-builder loan is to have monthly payments reported to the credit bureaus. Paying it off early would mean fewer months of positive payment history.
Credit-Builder Loan Alternatives
A credit-builder loan is a way for people with bad credit or no credit to improve their credit standing. However, credit-builder loans are not the only way for people in this situation to build credit. Other options include getting credit cards, being an authorized user or taking out a traditional personal loan.
People with bad credit or no credit have a high chance of qualifying for a secured credit card if they can put down the minimum security deposit (usually $200 - $300). But there are also unsecured cards (including student cards) that don’t require a credit history.
Credit cards are the best way to build credit because they report to the credit bureaus monthly whether or not you make any purchases. Making a small purchase and paying in full by the due date will build your score most quickly. But the most important part of building credit with a credit card is to make on-time payments.
If can’t get your own credit card account or don’t want to, you can become an authorized user on someone else’s account. As an authorized user, you can make purchases using the primary user’s credit line if they allow you to do so. But only the primary cardholder is responsible for paying. If the primary cardholder pays on time and the two of you keep a low credit utilization ratio, both of your credit scores will improve.
Some lenders will offer personal loans to people with bad credit. But they will likely charge high interest rates – as high as 36% in some cases. Federal credit unions cap their rates at 18%, however, and some may accept applicants with bad credit.
Another alternative is a secured personal loan, where you must put up collateral to take out the loan. But if you default, you could lose your collateral to the lender. Both secured and unsecured personal loans report payments on a monthly basis to the credit bureaus.
Credit-builder loans can be a good option for people who have a few hundred dollars they’re willing to temporarily part with in order to build their credit. Though you won’t get all of your money back, considering that you’ll have to pay interest, the improvement in your credit is worth more. It will help you on your way to getting financial products with better terms in the future. And the better your credit score is, the easier other aspects of life may become as well, like getting an apartment or a job.