What Is a Credit Builder Loan?

by A G // in Build Credit

If you need an easy way to start building your credit, a credit builder loan could be what you’re looking for

If you’re looking for a way to build or rebuild your credit score, a credit builder loan might be just what you need. Credit builder loans are becoming more popular with people with little or no credit history and can be a great way to save money.

What Is a Credit Builder Loan?

A credit builder loan holds the amount borrowed in a bank account while you make payments on it. These made payments build your credit score.

A credit builder loan differs from a traditional loan, where you receive money upfront and pay it back over time. A credit builder loan is the opposite: You make fixed payments to the lender and then get the total amount at the end of the term.

It’s like a fixed savings account that allows you to build credit with a lump sum of money that you have “saved” at the end of the payment term.

The best thing about credit builder loans is that they do not require good credit. However, you need to have enough income to prove that you can make the necessary payments.

Credit builder loans are suitable for people new to building credit or who haven’t started yet. People with existing debt will not benefit as much from a credit builder loan.

How Does a Credit Builder Loan Work?

Credit builder loans have acquired a few names over the years, including “start over loans” and “fresh start loans.” They aren’t advertised often and will usually only be offered by smaller lending institutions like community banks and credit unions, as opposed to big banks.

If you are approved for a credit builder loan, the amount you borrow is held in a bank account while making payments. You typically can’t access the money until it has been fully repaid, which means there’s also time for building savings and improving your credit score at once.

This acts as an insurance policy on behalf of lenders who take risks if applicants have little experience buying things with plastic or bad scores.

The good thing about credit builder loans is that the payments you make are reported to the three major credit bureaus (Equifax, TransUnion, and Experian). The more payments you make, the better your credit score will become.

Credit models such as FICO and VantageScore pay the most attention to payment history, so you must make your payments on time.

Where To Find a Credit Builder Loan

  • Community banks or credit unions: There are a lot of credit builder loans out there, but you might have better luck at your local community bank or credit union. They typically require more for membership other than just living in the proper county. Sometimes they need people to work for specific companies or worship at a particular church. But these smaller banks also offer interest rates that can’t be beaten, so it pays to check around.
  • Online lenders: A quick search will show you online lenders that offer credit builder loans. Check to make sure they are licensed to practice in your state. Online lenders’ terms and interest rates will vary.
  • CDFIs: If you strike out with community banks, credit unions, and online lenders, you could try a Community Development Financial Institution. These were formed to help lower-income communities, and there are about 1,000 in the U.S.
  • Lending circles: The idea of a lending circle has been gaining momentum in recent years. The concept allows friends and family members to get together to provide each other with interest-free “social” loans. In a lending circle, approximately ten participants each put in a certain amount of money each month, with the total going to one person. This continues until everyone has received a pot of money.

How To Manage a Credit Builder Loan

  1. Choose the best loan for you: You need to choose a loan that you can afford to pay. If you get a loan that is too large, you risk the chance of missing a payment and damaging your credit score. Keep your term to no more than 24 months.
  1. Ensure you pay on time: Missed payments of more than 30 days will go on your credit report. Pay your bill on time, and your credit will improve.
  1. Monitor your credit score: You need to monitor your credit score to ensure it goes up after you make your payments. It may take a few weeks for your score to change significantly after making payments, but most credit score monitoring companies update your credit score weekly. The big three credit bureaus all have credit monitoring programs as well.
  2. Have a plan for your loan proceeds: The best part about credit builder loans is that you get your money once you’ve paid for it (hopefully with a better credit score too). Your best bet is to keep that money as an emergency fund so that you don’t miss any future payments, which could damage all the hard work you have done for your credit.

Other Credit-building Options

Here are a few other options for ways to build your credit if a credit builder loan isn’t right for you.

  • Share- or certificate-secured loan: This option is good if you already have money in the bank. The money in your account is frozen until the loan is paid off. You can also be partially “thawed” as you pay back the money. Some lending institutions might be able to lend money against the value of your car.
  • Get a secured credit card: A secured credit card usually requires a $200 deposit and only lets you spend preload money that is on your credit card.
  • Ask to be an authorized user on a friend or relative’s credit card: If you can become an authorized user on someone else’s card, you build credit as they pay off their debts. Their account history is added to your credit report.
  • An unsecured loan: If you want to build credit but need the money immediately, you might have to use an unsecured loan. This is where they loan you money based on your credit history and not on your collateral. If you have poor credit, your loan interest rate will be higher, possibly as high as 36%.

Final Thoughts

A credit builder loan could be just the ticket if you want to increase your credit score. A credit builder loan is different than a regular loan because you don’t get the money for the loan right away. The loan is held in an account, and you make payments on it every month to build up your credit. Once the loan is paid off, you get the money you paid.

Many smaller financial institutions offer credit builder loans at reasonable rates. There are also other places to find credit builder loans, or you could try different methods to build your credit.

Whichever way you build your credit, know that having a decent credit score is vital to having a healthy financial future. Start with a small credit builder loan, watch your score rise, and then move on to other credit tools. Above all, pay your bills on time!

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