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A credit-builder loan allows you to make fixed payments into a savings account over several months. At the end of the term, the lender will return to you the balance of the account—possibly including some of the interest you paid—and you'll strengthen your credit with positive payment history.
If you have poor credit or no credit history, a credit-builder loan could be a good tool to demonstrate that you're a reliable borrower and build your score. But before you consider applying, here's more on how exactly credit-builder loans work, where to get one and alternatives to consider.
How Does a Credit-Builder Loan Work?
A credit-builder loan is a type of installment loan designed to help you build credit by establishing a positive payment history. You may be able to take out a credit-builder loan from around $300 to as much as $1,000, and loan terms typically range from six to 24 months.
Credit-builder loans work in the opposite way that typical personal loans do. Instead of getting funds upfront in a lump sum, you make payments each month and receive your balance at the end of the loan term. Here's how it works:
- The lender earmarks funds. The lender sets aside a certain amount of its own money in a savings account.
- You make monthly payments. You make installment payments toward the loan each month.
- You build credit over time. Credit-builder lenders typically report your payment history to the credit bureaus, helping you strengthen your credit with on-time monthly payments.
- You receive your money at the end of the loan term. Once you've paid the full loan amount, you'll get back the balance.
- You may pay interest and fees. You'll typically pay interest on the loan, but the lender may return a portion of that paid interest or the interest earned on the savings while in the account to you at the end of the loan term.
How Can a Credit-Builder Loan Help My Credit?
Credit-builder loans help you build credit by establishing a positive payment history. As a type of installment credit, credit-builder loans have fixed monthly payments. Making on-time payments contributes to healthy credit scores because payment history makes up 35% of your FICO® Score☉ , the credit score used by 90% of top lenders. Your payment history has the single largest impact on your credit.
By making on-time payments, you'll show lenders you can be trusted to take on other lines of credit in the future. That can help you build credit if you don't yet have any accounts, and it can help restore credit if you have negative marks on your credit report.
Where to Get a Credit-Builder Loan
You may be able to get a credit-builder loan from these different types of lenders:
- Credit unions: Many credit unions offer credit-builder loans; search your local institutions' websites to see your options. You'll need to become a member of the credit union to get a loan, and you'll qualify based on characteristics such as where you work or where you live. To join the credit union, you'll typically pay a membership fee of $5 to $25 or donate to a partner charity.
- Community banks: These locally owned banks may also offer credit-builder loans, and they have a focus on financial education similar to credit unions. Search for a community bank near you using the Independent Community Bankers of America's search tool.
- Lending circles: Peer groups can help each other build credit using lending circles, which offer interest-free loans usually facilitated by a community organization. The group decides on a monthly payment and loan balance, and each member pays the same amount per month to a central fund. Every month, one member receives a loan in the agreed-upon balance. In the meantime, monthly payments are reported to the three credit bureaus. You can look up lending circles in your area using the nonprofit Mission Asset Fund's database.
When considering different credit-builder loan options, be sure to compare interest rates and fees. Also, check whether you'll get back a portion of the interest that accrues on the balance.
You should also look for a lender that reports to all three credit bureaus (Experian, TransUnion and Equifax) so that your on-time payments can help your credit scores across the board.
Learn more >> How to Get a Credit-Builder Loan
Is It Hard to Get a Credit-Builder Loan?
Credit-builder loans may be easier to qualify for than other types of credit because they're designed for borrowers with limited or damaged credit histories.
You may not need to undergo a traditional credit check to apply for a credit-builder loan. Instead of using your credit score as a baseline for approval, some lenders may use your banking history through the consumer reporting agency ChexSystems. In this case, activities like bounced checks could affect whether you're approved for a loan.
What Are the Requirements for a Credit-Builder Loan?
You may be asked to provide some or all of the following when you apply for a credit-builder loan:
- Employment information
- Pretax monthly income; lenders may allow you to deduct any alimony or child support you receive from this total
- Pay stubs as proof of income
- If self-employed, tax returns as proof of income
- Total housing payment
- Other loan balances
- Checking and savings account balances
- References
Are Credit-Builder Loans Worth It?
Applying for a credit-builder loan may be a worthwhile strategy if you want to build credit from scratch or rebuild a damaged score and would have difficulty getting approved for other forms of credit. That said, as is the case with any credit product, it's important to carefully weigh the benefits against risks.
First, as is the case with any loan, if you're unable to afford your monthly payments, you could end up damaging your credit. Be sure to budget carefully to ensure you're able to pay on time each month before you apply for a loan.
Also, be sure you understand how much the credit-builder loan will cost you in interest and other fees. Say, for example, you apply for a credit-builder loan of $1,000 with a 12-month term and 5% annual percentage rate (APR) with a credit union. You'll pay $86 per month, including $27 in interest. At the end of 12 months, your credit union will return the $1,000 to you. You may also receive a portion of the interest you paid back, but this depends on the specific lender's policies.
Other Ways to Build Credit
Getting a credit-builder loan isn't the only way to give your credit profile a boost. Here are some other ways you may be able to build credit:
Apply for a Secured Credit Card
Unlike a traditional unsecured credit card, a secured credit card requires you to make a deposit, generally $200 to $2,000, which usually becomes your credit limit. You can use the secured card like a traditional card, charging small amounts and paying your full balance each month. Over time, if you use the card responsibly, the bank may be willing to convert it to a regular unsecured credit card. Make sure the issuer reports your account activity to the credit bureaus so the card will, in fact, help you build credit.
Become an Authorized User
Authorized users on credit card accounts are not responsible for making payments, but they can still use the account if the primary cardholder agrees. Payment history on the card will appear on their credit reports. Not all creditors report authorized user accounts to the credit bureaus, though, so ask before being added.
Apply for a Personal Loan
If you're able to qualify for one, you might also consider using a traditional personal loan to build credit. There are two types of personal loans to consider:
- Secured personal loans are backed by collateral, which the lender could take possession of if you don't repay the loan as agreed. While a secured personal loan can help you build credit, the prospect of losing the collateral you put up—such as your car—could make this a riskier option than, say, a secured credit card that requires a small cash deposit.
- Unsecured personal loans aren't backed by collateral, so they may have higher interest rates and be harder to get than secured personal loans. Lenders will look at your income, credit scores and other financial obligations that affect whether you can repay the loan. But like secured personal loans and other installment loans, making on-time payments can bolster your credit score.
Try Experian Boost®ø
Experian Boost is a free feature that allows you to integrate eligible rent, utility, cellphone and some streaming service payments into your Experian FICO® Score. It works instantly, and will only pull positive payment history from your bank account or credit card into your credit file. Improvements to your credit only apply to your FICO® Score powered by Experian.
Frequently Asked Questions
Just like any other credit product, a missed payment on a credit-builder loan could negatively impact your credit score. But the effect depends on how late you made the payment. If it's a few days late, the lender may only charge you a late fee, depending on its policies. If you make the payment 30 or more days past the due date, it will likely be reported to the credit bureaus and will stay on your credit report for seven years.
It is possible to pay off a credit-builder loan early by paying the entire remaining balance at once rather than paying in monthly installments. But this will limit your opportunities to build credit, since you'll make fewer on-time monthly payments to add to your credit report.
Once your loan is paid off, you'll get access to the principal amount and possibly any dividends received in a savings account held by the lender. You can then withdraw the money or leave it in savings and add to it. You can also apply for another credit-builder loan if you'd like to continue growing your credit.
The Bottom Line
Credit-builder loans are a financial win-win. They offer the opportunity to build credit and savings at the same time, at relatively low interest rates and with the chance to earn dividends. They're a wise choice if you're looking for a way to kick-start your credit journey or get back on track. By improving your credit score, you're taking one of the most meaningful steps possible to make your financial dreams a reality.