What Is a Credit-Builder Loan?
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. Plus, 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.
How Does a Credit-Builder Loan Work?
A credit-builder loan works the opposite way of a regular personal loan. With a credit-builder loan, the lender puts money into a savings account for the “borrower.” They then pay the lender monthly installments and receive the money in the savings account at the end of the loan term. Before opening the loan, the borrower may have to pay a small, one-time administrative fee. Some lenders may also charge a fee for late payments.
How a Credit-Builder Loan Works
- 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.
- 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.
How to Get a Credit-Builder Loan
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.
Best Places 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.
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.
Credit cards
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.
Authorized user
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.
Personal loans
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.
Bottom Line
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.
However, before you take out a credit-builder loan, be sure to consider your other options first. Depending on your situation, a credit card or a personal loan may be more helpful.
Ask the Experts
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?
Ask the Experts
Ph.D. – Assistant Professor of Finance – Westfield State University
Read More
Lecturer of Business – Davis School of Business – Colorado Mesa University
Read More
Ph.D., – Assistant Professor of Finance– Labovitz School of Business and Economics –University of Minnesota Duluth
Read More
Ph.D., – Professor of Finance – Reiman School of Finance – Daniels College of Business – University of Denver
Read More
Ph.D. – Assistant Professor of Economics – Sweet Briar College
Read More
Visiting Assistant Professor of Economics – Else School of Management, Millsaps College
Read More
