How Does a Credit-Builder Loan Work?
A credit-builder loan works like a regular personal loan but in reverse. With a credit-builder loan, the lender puts money into a savings account for you, and you then pay the lender in monthly installments in order to receive the money in the savings account when the loan term ends. Credit-builder loans typically have APRs of 6% - 16%, and they usually last for 6 to 24 months.
The lender will also report your payments to the credit bureaus monthly. If you make on-time payments, your credit score will increase. If you don’t, your score will suffer.
Learn more about how a credit builder loan works.
To get a credit-builder loan, you’ll need to start by comparing offers from the few banks and credit unions that currently have them. If you meet all of your chosen lender’s requirements, then you have a good chance of getting approved when you apply. The most common requirements for a credit-builder loan are being at least 18 years old, having a valid bank account and having enough income to make monthly payments.
Below is a complete list of the steps to get a credit-builder loan.
- Find lenders that offer credit builder loans: Most major lenders do not offer credit-builder loans, so you’ll have to do your research. WalletHub’s picks for the best credit-builder loans are a good starting point.
- Compare your options and choose one that’s best for you: The most important things to look at when considering your options are the loan amounts, APR ranges, term lengths and fees. You may want to check if the savings account the lender puts the money in is interest-bearing, as well.
- Apply for the loan: The application will require some personal and financial information like your address, income, employment status and housing status.
- Make monthly payments until you can get the money: Once you’re approved, you’ll need to make monthly payments to the lender until your loan term ends. This could take anywhere from 12 to 24 months.
Learn more about how to get a credit-builder loan.
These companies offer the best credit-builder loans because they have a wide range of repayment periods and low APRs. Learn more about the best credit-builder loans.
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.
To gain more insight about credit builder loan, WalletHub posed the following questions to a panel of experts. Click on the experts below to view their bios and answers.
1. What types of people do you think would benefit the most from a credit-builder loan?
2. What advice would you give to someone before they apply for a credit-builder loan?
3. What common pitfalls should people keep in mind when it comes to credit-builder loans?
4. Which are more consumer-friendly: credit-builder loans or secured credit cards?