Having a positive and established credit history is essential to taking out a loan, renting an apartment, or even getting a job.
With bad credit or no credit, everyday tasks become much harder since lenders can't take a close look at your credit history.
So what to do next? A good solution is to look into a credit builder loan, which can help you build or rebuild your credit. When used correctly, this loan builds a history of positive payments and eventually generate a good credit score.
Credit builder loans are offered by local banks, credit unions, and online services. The borrowed amount is held in a secured account while you make regular payments on the loan. These payments show your potential lenders that you are serious about improving your finances and that you can be trusted with loans, credit cards, and mortgages.
Once the credit builder loan is completely paid off, the funds are released to you.
Credit builder loans are personal loans designed to help people improve their credit scores by making timely payments over an extended period. The best credit builder loans offer quick and easy applications, reasonable interest rates, and minimal additional fees.
We’ll explore the best credit builder loan options so you can find one that works for you and start improving your credit score.
What is a credit builder loan?
A credit builder loan is a type of loan designed to help consumers improve their credit scores. Unlike traditional loans, the purpose of a credit builder loan is not to fund a purchase. Instead, funds from a credit builder loan are held in a savings account while the borrower makes regularly scheduled payments over a fixed amount of time.
Borrowers use credit builder loans because the payments are reported to credit bureaus, which can help build credit history and increase credit scores. While the interest rates for credit builder loans may be higher than traditional loans, the potential benefits of improved credit scores can lead to better loan terms, lower interest rates, and better finances in the long run.
How does a credit builder loan work?
A credit builder loan functions like an installment loan, where the borrower takes out a loan and repays it over a set period of time with regular payments. However, unlike other types of loans, the money borrowed is not given to the borrower upfront. Instead, the funds are locked in a savings account or certificate of deposit (CD) and held as collateral until the loan is repaid in full. Then, once the loan is repaid, the borrower can access the loan amount. Additionally, some lenders return a portion of interest or fees to borrowers at the end of the loan.
By making on-time payments, the borrower makes progress toward building a credit history and ultimately towards establishing better credit scores. For that reason, this type of loan can be a useful tool for individuals who want to improve their credit, as it allows them to build positive payment history and gradually improve their credit scores over time.
Do credit builder loans earn interest?
Credit builder loans do not typically earn interest. Rather, these loans include regular payments of interest and principal. The interest rates on these loans can be higher than what you would find with a traditional loan because borrowers typically have bad credit or no credit.
In addition to ongoing interest, some lenders charge fees for setting up credit builder loans. Before you take out credit builder financing, read the loan agreement carefully to understand the applicable fees and interest rates.
How to get a credit builder loan
Follow these steps to get a credit builder loan:
- Determine your eligibility. To qualify for a credit builder loan, you need to meet certain criteria, such as age, income, and employment.
- Shop around. Research different lenders to compare rates and fees associated with credit builder loans.
- Complete the application process. Fill out an online or physical application with details including your name, address, Social Security number (SSN), date of birth, and contact information.
- Provide the required documentation. You’ll need to supply proof of identity (such as a driver’s license or passport), proof of income (such as pay stubs or tax returns), and other documents the lender may require.
- Sign the agreement. Once your loan is approved, sign any required paperwork before the lender transfers funds into your savings or escrow account.
- Make payments on time. Regularly make payments according to your payment schedule to build up positive credit over time while paying off your loan.
- Monitor progress. Track your credit score and review statements from the lender to make sure payments are applied correctly and that you’re on track to improve your credit score.
The biggest thing that sets credit builder loans apart from more conventional types of financing is what happens once the loan is repaid. Once you finish paying back your credit builder loan, you’ll gain access to the original loan amount. Sometimes, you’ll also be refunded a portion of the interest and fees you paid on the loan.
How much can you get with a credit builder loan?
Credit builder loan amounts vary by lender, loan type, and specifics such as your income and existing credit. Typically, credit builder loans range from a few hundred to a few thousand dollars.
Regardless of the amount, the goal of a credit builder loan is to establish a pattern of consistent, on-time payments to show lenders you’re a reliable borrower. With regular payments, a credit builder loan can help you build your credit score and may even lead to better borrowing options in the future.
Pros and cons of credit builder loans
Credit builder loans can be a great tool for anyone looking to improve their credit and access better borrowing options in the future. However, these loans also have drawbacks. Do your research and understand all the costs associated with a credit builder loan before you take out a loan.
Pros of Credit Builder Loans
- Payments can be reported to credit bureaus. Making regular payments on a credit builder loan can help demonstrate your reliability as a borrower and improve your credit score.
- Ability to build positive credit history over time. One of the main advantages of credit builder loans is that they help you build positive payment history, which is one of the most important factors in determining your credit score.
- Access to better borrowing options in the future. The purpose of a credit builder loan is to start building your credit history and increasing your credit score. Over time, this can lead to more favorable loan terms when you’re ready to borrow money.
- Accessible even with no credit or bad credit. A credit builder loan is available to those with little or no access to traditional loans. It can be used to start building your credit even if you can’t access a regular loan.
Cons of Credit Builder Loans
- Payments must be made on time. One of the main disadvantages of a credit builder loan is that payments must be made on time and in full every month for your credit score to improve. If you fail to make payments, your credit score could take a hit.
- Includes interest and other fees. A credit builder loan typically comes with several fees and charges, such as application fees, closing costs, origination fees, prepayment penalties, and interest. You may get some of these costs back at the end, but probably not all.
- No immediate access to loan funds. With a credit builder loan, you don’t have immediate access to the funds you’re borrowing. This can be a disadvantage if you need money for an emergency or other necessary expenses.
- May take time to see results. It typically takes at least six months for your payments to be reported to the three major credit bureaus and start positively impacting your credit score.
- Could lead to more debt. A credit builder loan can help you build your credit over time, but if you’re not careful with how much you borrow, it could actually lead to more debt.
- May require collateral. Depending on your credit score, lenders may require you to have some form of collateral or other assets to qualify for the loan. This could include a car, house, or other valuable asset.
- May require a cosigner. If you have bad credit or no credit history, lenders may require that you have a cosigner for the loan.
Who credit builder loans are right for
Credit builder loans are often a good fit for:
- People who have little or no access to traditional loans
- Individuals with poor credit scores who are looking to rebuild their credit
- Borrowers looking for a long-term solution to improve their financial security
- Those seeking better loan terms and lower interest rates in the future
- People with no credit history who are looking for a way to build credit over time
How to choose a credit builder loan
Choosing the right credit builder loan can be daunting, especially for those with limited access to traditional forms of credit. With so many lenders offering these loans, it’s important to do your research and make sure you understand all the costs associated with a credit builder loan before making any decisions. Then you can determine if a credit builder loan is right for you and how it can help you reach your financial goals.
Here are some things to consider when choosing a credit builder loan.
Loan fees and APRs
Loan fees can vary widely depending on the lender, so look for lenders who charge reasonable fees and are transparent about their costs. Additionally, annual percentage rates (APRs) can also be helpful for comparing loans. The APR includes not only the interest rate but also any fees or other charges. When comparing loans, look at the APR rather than just the interest rate. This will give you a better idea of the true cost of borrowing and help you choose the loan that’s right for you.
Repayment terms
Like interest rates, repayment terms can also vary by lender. Some terms that vary include fixed or variable interest rates, repayment periods, and the frequency of payments. Fixed interest rates mean your interest rate will not change throughout the loan term, while variable interest rates may fluctuate based on market conditions.
Repayment periods can range from six months to several years, with longer repayment periods usually resulting in smaller monthly payments but higher overall interest charges. Lastly, payment frequency can range from bi-weekly to monthly payments. Understanding these key components can help you find the right loan.
Provider reputation and reviews
A provider’s reputation indicates the level of service and quality of its offerings. When evaluating a lender’s reputation and reviews, look for consistent positive feedback and potential red flags, such as poor customer service or hidden fees. Take the time to conduct research and read reviews on the providers you’re considering before deciding which to use.
Where to get a credit builder loan
A credit builder loan can be a great way to improve your credit and access better financing options. However, with so many lenders offering these loans, it can be difficult to know where to start. Here are some of the best places to get a credit builder loan:
- Local banks and credit unions: Many local banks and credit unions offer credit builder loans as a way for individuals to establish or improve their credit history. The loans are typically small, ranging from a few hundred to a few thousand dollars, and are designed to be repaid over a set period of time. These loans often have lower interest rates and no prepayment penalties, making them an affordable option for those who want to build credit without breaking the bank.
- CDFIs: Community Development Financial Institutions, or CDFIs, offer credit builder loans specifically designed to help borrowers build credit. Common terms for credit builder loans include fixed monthly payment amounts, loan terms of six to 24 months, and interest rates that can be competitive with traditional loans. This option is particularly suitable if you live in an under-banked community.
- Nonprofit organizations: Some nonprofit organizations now offer these types of loans to help people build their credit profiles or rebuild their poor credit. These loans are often offered to particular borrower groups, including the under-served and less fortunate.
- Online lenders: With the growing availability of online lenders, obtaining a credit builder loan has become easier and faster than ever. Loan applications can often be completed in a matter of minutes, and loans close in as fast as a few days. To get started, research and compare online lenders to find the best rates and terms that fit your needs.
- Lending circles: A lending circle is a group of individuals who pool resources and loan money to each other, often at reasonable interest rates. To get a credit builder loan, join one of these groups and make regular, on-time payments. Loan terms can vary from group to group, so be sure to ask questions and understand the terms before signing up.
Credit builder loan alternatives
If you’re looking for a way to build your credit without taking out a loan, there are several alternatives to consider. These options can help you establish or improve your credit history without borrowing money and paying interest. From local banks and credit unions to online lenders and nonprofit organizations, there are many different ways to start building positive credit over time.
Here are some of the most popular alternatives to traditional credit builder loans:
Certificate-backed loan
Certificate-backed loans are a unique type of loan that requires you to put down a lump sum of cash in exchange for a loan. This lump sum is then used as collateral, meaning that if you default on the loan payments, the lender can take possession of the cash to cover the outstanding balance.
Unlike credit builder loans, certificate-backed loans require you to have some cash on hand, making them a good option if you have saved up some money and want to use it to improve your credit. Additionally, as certificate-backed loans are secured by the deposit, they typically offer lower interest rates than unsecured loans, providing a smarter and more affordable option for building credit.
Certificate-backed loans are ideal if you want to build their loans using a full-secured loan with very little personal liability.
Secured credit card
A secured credit card is a type of credit card that requires a security deposit to be approved for use. This deposit serves as collateral on any credit extended by the issuer to fund purchases. It can range from a few hundred to a few thousand dollars. Once the deposit is made, you can use the card just like a regular credit card, with the credit limit typically equal to the security deposit amount. You are then responsible for making timely payments on the balance, just as you would with any other credit card.
A secured credit card can be a good alternative to a credit builder loan if you do not qualify for a traditional credit card or loan or are looking to build or improve your credit history. By using a secured credit card responsibly, such as making timely payments and keeping the balance low, you can demonstrate creditworthiness to lenders and potentially qualify for better credit terms in the future.
Personal loan
A personal loan is a type of loan consumers can use for a variety of personal expenses, from consolidating debt to funding home improvements. When you get a personal loan, you typically receive a lump sum of money from a lender, which you repay over a fixed period with interest. The interest rates on personal loans can vary depending on your credit score, income, and other factors.
When deciding between a personal loan and a credit builder loan, it’s important to consider your specific needs. A personal loan may be a good alternative if you need a larger sum of money upfront or need to fund a specific expense. In contrast, a credit builder loan may be better if you may have trouble getting approved for a personal loan or need to focus on improving your credit. However, the right option for you may vary by lender, rates, or specific loan terms.
Co-signed loan
A co-signed loan is a loan that involves applying for a loan with a cosigner who takes equal responsibility for repaying the loan. Usually, a cosigner is a person with a higher credit score and financial stability who helps you get approved for the loan. Co-signed loans allow lenders to take into account the creditworthiness and income of both you and the cosigner. As a result, co-signed loans often have lower interest rates and better terms.
A co-signed loan may be a good alternative to a credit builder loan if you don’t have a strong credit history but need to borrow a significant amount of money and have a friend or family member willing to help you qualify for financing. However, before applying for a co-signed loan, both you and your co-signor should be aware of the risks involved, as late or missed payments may negatively impact both of your credit reports.
Authorized user
Another alternative to a credit builder loan is becoming an authorized user on someone else’s credit card account. Essentially, an authorized user is an individual who has been granted permission to use someone else’s credit card account. This permission can come with certain restrictions, such as a set limit on the amount that can be charged.
However, it’s important to note that not all credit card issuers report authorized user activity to credit bureaus. So, as an authorized user, your credit score can benefit from the primary cardholder’s responsible credit usage. However, if the primary cardholder does not use their credit card responsibly, paying off their balances in full and on time, it can hurt your credit as well as theirs.
Becoming an authorized user can be an excellent alternative to a credit builder loan if you have a trusted friend or family member who is willing to add you to their account, and you can benefit from their responsible credit usage.
Rent-reporting services
Rent reporting services are platforms that allow renters to report their monthly payments to credit bureaus. This modern approach bridges the gap between landlords’ records and credit reporting agencies, which traditionally have differed in their record-keeping methods. To use this type of service, you must register with an online platform and permit it to access your rental payment history. The platform then verifies the information with the landlord before providing the data to credit reporting agencies.
Rent reporting helps build credit scores by adding reliable and consistent data that credit bureaus can use when calculating creditworthiness. If you are someone who rents but avoids taking out loans, then rent reporting services might be a better option for you than a credit builder loan. Not only does it boost your credit score, but it does so without you needing to borrow money for a house or car or take out a credit card. It can be especially beneficial if you need help accessing traditional financing due to bad debts or a recent bankruptcy.
Ultimately, a credit check is an important part of qualifying for any type of financing. Whether you have bad credit or no credit at all, consider products like credit builder loans as ways to improve your credit scores.
Frequently Asked Questions
What is a credit builder loan?
Credit builder loans are specific loan products offered by banks and credit unions to help borrowers with little, no, or bad credit to build and improve their credit history. Your lender will report your payments to the three major credit bureaus: Experian, Equifax, and TransUnion, which establishes and builds your credit history.
How can I get a credit builder loan?
There are many places where you can shop around to find the right credit builder loan for you:
- Local banks and credit unions
- CDFIs (Community Development Financial Institutions)
- Nonprofit organizations
- Online lenders (such as Self Lender)
Who benefits from a credit builder loan?
Credit builder loans are best for those who have little or no credit and need to improve their credit, like recent college graduates or those who are trying to rebuild their credit after serious financial problems.
How quickly will a credit builder loan build your credit?
The time required to build credit with a credit builder loan varies depending on the borrower, the lender, and the repayment terms. Generally, it can take anywhere from six months to a year or more to significantly improve your credit score via a credit builder loan. However, it can take longer if you have recent bad debts or other issues on your credit report that need to drop off.
Is a credit builder loan a good idea?
A credit builder loan can be a good idea if you want to establish or improve your credit score. However, in cases where you need access to funds immediately to finance large purchases or cover other expenses, there may be better options than a credit builder loan. With a credit builder loan, you won’t get access to your loan amount until the end of your repayment term.
Do banks do credit builder loans?
Some banks offer credit builder loans. However, due to the high risk associated with these types of loans, many banks may require collateral such as a savings account or CD to secure the loan. Additionally, there may be fees and other costs associated with taking out such a loan, so you should understand all the terms and conditions before applying.
What builds credit the fastest?
What builds credit the fastest typically depends on several factors, including your income, net worth, credit history, and the current state of your credit report. For example, if your credit is low because you have a high credit utilization rate, the best thing you can do to improve your credit quickly is to lower your credit utilization rate.
However, if you’ve recently filed for bankruptcy or are building your credit from scratch, a credit builder loan can help to establish your credit with the three credit bureaus in just a few months by quickly establishing a history of making regular payments on time against outstanding debts.
In the longer term, the best ways to build your credit include making sure all of your debt payments are made on time and in full, keeping your credit utilization low, and taking out different types of loans such as auto loans, installment loans, and secured cards.
Can you pay off a credit builder loan early?
It is often possible to pay off a credit builder loan early. Some lenders may charge prepayment penalties or other fees for paying off a loan before its due date. However, the overall benefit of improved credit scores and better borrowing options in the future may outweigh these costs.
Additionally, by paying off the loan early, you can avoid additional interest payments or late fees that come with an outstanding loan balance. If you are able to make prepayments on your credit builder loans and have enough funds available to do so responsibly without hardship, then it can be a great way to save money while also helping improve your long-term borrowing potential.
Do credit builder loans require credit checks?
Credit builder loans generally require a credit check as part of the application process. These credit checks help lenders evaluate a borrower’s creditworthiness, whether they qualify, and what kind of interest rate and repayment schedule should be offered. This process also helps ensure that borrowers can afford to make regular payments on time and provides some assurance the borrower will ultimately pay off the loan in full.
