What is a Credit Builder Loan?

A credit builder loan follows a different process than other types of loans. Here’s how it works:

1. Deposit secured funds

You can typically get a credit builder loan through credit unions, banks, and online lenders.1 Once you’re approved, you don’t get a lump sum upfront.

Instead, you’ll make fixed payments (including the principal amount and any interest) into a secured account on a timely schedule, which you get access to at the end of the loan term.¹

2. Make consistent payments

You make monthly payments, including interest, over the course of 12 to 24 months1 to show to lenders that you can manage your account responsibly with consistent, on-time payments.

3. Credit reporting

These types of loans to build credit can be a helpful option since the lender reports your payment activity to major credit bureaus like Equifax^®, Experian^®, and TransUnion^®.²

Timely payments contribute positively to your credit history, while late payments can hurt your score.

4. Receive your funds

Once the loan is paid off, the funds (minus fees or interest) are made available to you. Some lenders may even offer you the interest you paid as well, allowing your money to grow while it’s held.²

Having a strong credit history heavily depends on your payment history, which makes up 35% of your FICO^® credit score.³ That’s why making on-time payments on a credit builder loan can give your credit a positive boost.

A credit builder loan can also help you add a new account to your credit report. This can be helpful since ‘credit mix’ affects 10% of your credit score.³

Missing a payment can still hurt your credit score, so positive results aren’t guaranteed.

Credit builder loans are designed for:

• People who have limited access to traditional credit products.
• People who have no credit history as a young adult or want to establish credit later in life.
• People who are rebuilding their credit score due to situations like missing payments on loans, delinquencies, or even filing for bankruptcy in the past.
• People who have an average credit score but have been denied for loans and credit cards.

Taking out a credit builder loan for bad credit may help you improve your credit score so you can qualify for better loan terms and lower interest rates.

If you’re looking for a credit builder loan, you have several options.

• Credit unions and banking institutions: Many banks and credit unions offer credit builder loans with various terms. You can check with your current financial institution to see if they can give you any special offers, or compare your options across multiple banks to find the best fit for you.
• Online lenders and fintech companies: If you’re looking for a credit builder loan, online lenders can be a great place to start.

Like any financial tool, credit-builder loans come with both advantages and drawbacks. Here’s what you need to consider.

Pros:

• You can build credit history with on-time payments.
• You don’t need existing credit to qualify.⁴
• They help you save, since the loan amount is held until you’ve made your final payment.
• The fixed monthly payments help with budgeting.

Cons:

• You get no money up front like with a traditional loan.
• Missing payments can hurt your credit.
• Interest and fees may apply, like a one-time processing fee.⁴
• You can’t access the funds during the repayment period.

Credit-builder loans can be a great stepping stone if you’re looking to build or repair your credit. But like any financial product, they’re not one-size-fits-all. Before you sign up, here are a few things to keep in mind.

• Late payments can still hurt your credit. While the whole point of a credit builder loan is to improve your credit, missing a payment can have the opposite effect. Late payments can be reported to the credit bureaus and may lower your credit score. Only borrow what you can realistically afford. Set up reminders or automatic payments to stay on track.
• Some lenders charge fees or interest. Many credit builder loans are low-cost, but that doesn’t mean they’re free. Some lenders charge interest, application fees, or account setup fees.⁴ These costs can reduce the amount of money you receive at the end of your loan term. Always read the fine print and ask questions so you understand exactly how much the loan will cost you.
• Lenders consider various factors to determine if you qualify. Although most lenders don’t check your credit score when you apply, some may still do a hard credit inquiry and consider other factors like your debt-to-income ratio and income.^1,5 If you still have significant outstanding debts, for example, it may be a better idea to pay down those debts to improve your credit score. Then, apply for a credit builder loan if you still think it’s a good option.
• Make sure your lenders report payment history to all three credit bureaus. The goal of a credit-builder loan is to build a solid credit history, so make sure your payments are reported to all three major credit bureaus (Equifax, Experian, and TransUnion). If the lender only reports payments to one or two of the credit bureaus, this could weaken the impact on your credit score. Be sure to confirm reporting policies before applying.

If a credit builder loan doesn’t seem like the right choice for you right now, don’t worry. There are several other tools that can help you build or rebuild your credit history.

Personal loans

A personal loan can help build your credit if used responsibly, but they are intended to help you borrow money you need for a specific purpose. These loans come with fees and interest charges, but you can commit to making payments on time to boost your credit score.⁵

Secured credit cards

A secured credit card requires a cash deposit before you can use it. The cash deposit is typically equal to your credit limit.⁶ For instance, if you deposit $200 into your account, you have a credit limit of $200.

With a secured credit card, you use your own money to cover each transaction. A secured credit card is similar to a debit card in that you can’t spend more than you’ve deposited. The benefit of a secured card is that your payment information is reported to the credit bureaus.

Authorized user

If you have a friend or family member willing to add you to their credit card as an authorized user, this can help you build your credit.

As an authorized user, you are not responsible for a late or missed payment, but you can use the credit card to make purchases.⁷ If the primary credit holder has a strong history of on-time payments, this can help you build your credit score over time.

A credit builder loan could be your first step to establishing credit or improving your credit, especially if you’re starting from scratch or repairing your score. By making regular, on-time payments, you can establish credit and develop financial habits that serve you well in the long run.

If you’re not ready for a credit-builder loan, consider exploring alternative ways to build your credit with these credit-building tips.