Credit Builder Loan: What You Should Know About Credit Building Loans

credit builder loan

Credit Builder Loan – Do Credit Building Loans Really Build Credit?

A credit builder loan is a unique type of loan where a bank or credit union holds the amount borrowed in an account while you make payments.  This lets you build credit while the bank limits the risk that you won’t make your payments. You only get the money when the loan is paid off.  Credit building loans are designed to help build up and improve the credit score for people who little or no credit history. There are solid reasons to build your credit in this way.  A good credit score makes approval for credit cards and loans more likely, and at better rates.  Credit-builder loans do not require good credit for approval. They do require that you have enough income to make payments. The bank is protected because the amount you borrow is held in an account while you make payments. 

Credit Building Loans – How They Work

You can usually qualify for a credit building loan even if you have bad credit or no credit. The lender reduces its risk that you won’t make your payments.  It does this by loaning you a certain amount of money, which it deposits into an account it controls. You make payments on the loan, and the lender reports those payments to the three major consumer credit bureaus —  TransUnion, Experian and Equifax.  This creates a credit history if you don’t have one, and it can also add to an existing credit history if it is below par. When the loan is paid off, the lender gives you access to the funds it held as collateral.  That is your money now to keep.
Credit building loans are taken out specifically for establishing credit and improving your score. Usually they’re provided by smaller. local banks and credit unions. Some nonprofits may offer these loans as well.  These loans are unique, in that they’re not designed for you to have access to the loan right away.  These loans are intended to help you develop a solid on-time payment history. They’re simply a tool to help you boost your credit score.

Credit Builder Loans – Why Banks will Make Loans to Risky Borrowers 

Because lending involves risk, lenders are more inclined to lend money to people who have good credit. They usually offer better terms and rates as well.  This is because good credit signals that someone has already demonstrated they are more likely to pay back a loan. But how do you build credit if a lender will not give you the chance to prove you are a good risk?  Obviously, it is difficult to build good credit unless a lender gives you a chance to prove you are worthy. Of course, this makes sense from a lender’s perspective.  They don’t want to risk losing money on an unknown borrower. From the borrower’s perspective, it’s frustrating if you’re trying to borrow and no lender wants to be the first to do business with you.

Credit building loans are a way lenders can provide you a loan without taking a risk that you won’t pay it back. With a credit builder loan, a lender doesn’t actually give you access to money you want to borrow.  At least not until you’ve paid for the loan in full.  In this way, they control the funds, and therefore don’t risk anything.  As a result, lenders that offer credit builder loans are more willing to give them to borrowers with poor or no credit. Once you’ve got the loan, the lender reports on your payment history to credit-reporting agencies. This helps you build credit, because you’re creating a history of on-time loan payments.

Reasons to get a Credit Builder Loan

Credit builder loans come in especially handy if:

  • Thin to no credit history – Getting credit is essential. Your credit history is reviewed regarding all aspects of basic existence including a living arrangements, transportation, background check for a job.
  • You prefer not to use other credit Taking on additional credit can build your credit score.  For example, multiple cards can build credit, but they can be a burden.  They can also get out of hand with many horror stories of unmanageable credit card debt.
  • Preparation for a financial milestone –  Buying a first home is an obvious hurdle. So is buying a car. Better credit means more attractive interest rates.  It’s just good planning to build your credit score first.
  • Starting over – Maybe you’re young and new to the US credit system, or rebuilding after a crisis. In either case, building credit can be challenging.  Credit building loans let you take control of your credit and improve it for the future.

How does a credit builder loan work to better your score?

A credit-builder loan can help build credit if you pay on time. Payments are reported to the three major credit bureaus, Equifax, Experian and TransUnion.  Payment history is weighted more heavily than any other factor in calculating your credit score. Therefore, making on-time payments on a credit-builder loan can help you improve your credit profile.

Credit-builder loans are typically offered by smaller financial institutions.  Local credit unions and community banks are likely lenders.  When you get a credit-builder loan, the money you borrow is deposited into a bank account held by the lender. You then make monthly principal and interest payments, for a term usually around six to 24 months. Your payment progress and history are reported to the three major credit bureaus. When the loan is paid off, you get to keep the money from the account.  The benefits of a credit-builder loan are twofold.  You’re building a savings account while also building your credit history.

These loans aren’t usually large. Most are within the $500 to $1,000 range. They’re designed to be reasonable to pay back. With interest, you will end up paying more than the original amount.  But, the extra amount you pay is small compared to the potential benefits of improved credit.  Better credit scores are usually eligible for more loans, better terms and better rates.  It works like this:

  • You make payments on the loan over time. A common loan requires monthly payments over a year or two.
  • The money is held in an interest bearing account – The lender puts the money in savings account under their control.
  • Your Payment progress is reported to the three major credit reporting agencies
  • You get the money once the loan’s fully paid.

Will a credit builder loan really improve your credit scores? 

Credit-builder loans can definitely improve your credit score, but it really depends on you.  Lenders report payments on these loans to credit bureaus. If you make your payments on time, this builds positive payment history.  For example, 35% of your FICO credit score is determined by your on-time payment history. So, keep in mind that if you’re late making a payment, that’ll be reported, too. When you don’t have much of a credit history, a single late payment can be a big setback. But, the flip side is that a year or two of ontime payments can boost your credit score – significantly.

Credit Builder Loan – are they all the same?

Credit-builder loans go by many names, such as Fresh Start Loans or Starting Over Loans. They’re not widely advertised.  Generally, they are offered by smaller financial institutions, such as credit unions and community banks.  Why do they do it? Financial institutions want to see you succeed. After all, if you become a customer, you’re more likely to bank with them in the future.  The lender is not going to make a lot of interest on the loan.  However, the lender is pretty much guaranteed not to lose money, either.  The lender will set strict limitations. Credit builder loans have been described as training wheels for credit.

There are three main types of credit building loans. 

A pure credit builder loan

The bank loans the money and puts it in a locked savings account, while you make payments. This option doesn’t require you to put down money up front. It’s more like a savings layaway plan.  Once you successfully make all your payments, the funds in the savings account are released to you.

A secured loan

You can secure the loan by using money you already have in savings. With a secured loan, the interest rate will likely be lower. Just remember, you can’t access the money untill it’s paid back.  This type of loan is a good way to build credit with an opportunity to establish a savings account.

An unsecured loan

With this option, you get cash up front to use for expenses. You then pay the money back at a predetermined rate. Interest rates may be slightly higher. If cash on hand is a priority, an unsecured loan may be your best bet—but you still need to be able to make payments. In that respect, it’s similar to a credit card.

After about six months, you’ll get a FICO score if you didn’t have one already. If you’re trying to build an existing score, you can see a jump of maybe 20 to 25 points over the loan’s life. It doesn’t sound like much, but it can make a difference.  For good results, though, you have to make timely payments. Not just on the loan, but on any other bills you have that are reported to credit bureaus. (Source:

How to Get and Manage a Credit Builder Loan

  1. Find a credit-builder loan. Look for ones with a payment level you can comfortably afford. Stretching your budget to make a higher payment won’t impress lenders. Choose a reasonable amount and a term no longer than 24 months. In addition to local banks and credit unions, some online lenders offer credit-builder loans.
  2. Confirm the lender will report payments to the three major consumer credit bureaus – Experian, Equifax, and TransUnion.
  3. Decide how much to borrow. The typical loan amount is between $300 and $1,000.
  4. Comparison shop among different lenders. There might be big variations in interest charged, monthly payment amounts, fees, repayment periods and loan origination costs.
  5. Apply for the loan. You’ll need to provide basic information, such as your name and address. But unlike with most loans, having bad credit when applying won’t disqualify you. If you are approved, the money you borrow is deposited in a savings account. Typically, you can’t access those funds until you have fully repaid the loan. This acts as a safety net for the lender that’s taking on risk if you have bad credit or no credit.
  6. Make payments on time, every time. If you pay the loan as agreed, the financial institution is obligated to send a good report to the credit bureaus. But a payment more than 30 days late can seriously hurt your score.
  7. Monitor your credit score. Personal finance websites offer free credit scores. Also, you are entitled to two free credit reports each year from all three of the major reporting agencies.  Don’t obsess over tiny movements, but look at the overall trend.
  8. Collect your loan proceeds, plus any interest. At the end of the loan term, you get the money — and likely a better credit score.

Who offers credit building loans? 

Credit Builder Loan Online

There are a number of online lenders that offer credit building loans.  Self (formerly Self Lender), for instance, offers loans with payments starting at $25 a month for a two-year loan. Interest rates are below 16%, and payments are reported to the three major credit bureaus.  There is no cost whatsoever to join Self.  Self is available in all 50 states and is accessible online and via a mobile app. Other online lenders offer credit building loans you can pay back in $25, $35, $48, and $150 monthly installments. The payment schedules range from 12-24 months.  Each time you make your on-time monthly payment, you benefit by improving your credit score.

Credit unions or community banks:

Around fifteen percent of credit unions offer this service. Credit unions typically have membership requirements.  Restrictions like living in a particular county, working for particular companies, worshiping in a certain church or making a small charitable donation.To see if you’re eligible to join a credit union, go to A Smarter Choice.  Another way to look is to search online for your state plus the term credit builder loan.

You may find credit building loans available at nearby community banks or credit unions.  They may offer the lowest interest rates, so it pays to check.  See if your bank has credit builder loan options. Or if you’re just opening a bank account, find a bank that provides this type of loan.

Community Development Financial Institutions

If your credit union or community bank doesn’t offer them, you might try a Community Development Financial Institution. These organizations exist to help lower-income communities.  There are about 1,000 of them in the United States. Capital Good Fund is a CDFI that makes small personal loans.  Their rates don’t exceed 24% APR, and they offer a credit-builder program at an additional cost.

Nonprofit Organizations

Nonprofits focused on economic development, or serving a specific population, may have credit builder loans as a financial empowerment tool for those they serve.  Consumer Action provides a directory of where to find credit builder loans in your state, including nonprofits, credit unions, and banks.  This list isn’t all-inclusive, but it’s a good place to start.

Lending Circles

There is a credit-building plan offered through the Lending Circles program.  It is run by nonprofit Mission Asset Fund. This practice is often used among families or friends.  Participants get and give interest-free social loans, with payments reported to credit bureaus. They are not available everywhere.  You can plug in your ZIP code to see if there is one in your community. In such groups, about 10 participants each agree to put in a certain amount per month.  The money rotates each month and goes to one person, in a round-robin fashion.  This occurs monthly until everyone has received their money back.

How much does a credit builder loan cost? 

Costs of a credit-builder loan vary depending on the lender. Here are important details to watch when looking for a potential loan.

  • The APR: APR, or annual percentage rate, is the amount your lender charges you to borrow the funds. An APR of less than 10% is common with credit-builder loans, but some have higher rates.
  • Interest payments: Lenders offering credit-builder loans may keep some or all the interest you pay, giving you only the remaining balance at the end of the loan term.
  • Other fees and costs: Lenders may charge an application fee for the loan or charge late fees if you don’t pay on time.
  • The loan repayment term: The longer your loan term, the more interest you’ll pay.
  • Maximum and minimum loan limits: You don’t want to borrow too much or too little. If you borrow a larger amount of money it could take you longer to pay back.  Ultimately, this results in paying more in interest over the life of the loan.

Finding a lender that offers favorable terms ensures you’ll be able to use a credit-builder loan to boost your credit without spending a fortune. Source:

Other Options for Building Credit

If you have money in the bank, you may have another option for an installment loan:

  • A share, or certificate-backed loan. A deposit you already have at the financial institution is the collateral. That money is frozen until the loan is repaid, or it may be incrementally released, as the loan is repaid. So if you have funds on deposit at a small bank or credit union, it may be worth asking if you can borrow against them to help reestablish your standing.
  • Secured by Auto – Other lenders may allow you to borrow against the value of your car.
  • Secured credit cards are another option. They can be very effective — but you first have to have enough money to pay the security deposit.
  • Unsecured Loans If you are trying to build credit and need the proceeds of a loan immediately (for debt consolidation, for example), you will probably need to take an unsecured personal loan.  That means the lender has no collateral, just the strength of your credit history, to rely on. If your credit is damaged or thin, you’ll pay higher interest rates, sometimes as much as 36%, which tends to be the ceiling with most reputable lenders.  Some lenders who will grant you unsecured personal loans without checking your credit at all, but those installment loans are much more like payday loans. The lenders don’t check your credit, but they also don’t report to credit bureaus. And the loans carry interest rates that can easily reach 300% or higher. Source:

Credit Builder Loans vs. Secured Credit Cards

  • A credit-builder loan can be a good option for someone who can’t qualify for a traditional credit card. It’s considered an installment loan for credit reporting purposes under the FICO scoring model. And as you make payments, the credit bureaus are notified, helping you potentially boost your credit score.
  • A secured credit card is also designed to help consumers build credit. These cards, however, require an upfront deposit. This becomes your credit limit, establishing the maximum amount you can spend with your card. If you fail to make payments, your credit card issuer can keep some of the money from your original deposit. Otherwise, you’ll constantly have access to revolving credit that you can use to spend on different items.

With a credit-builder loan, the lender puts money into a savings account on your behalf. The money isn’t yours until you’ve paid off the loan.  But you have a fully funded savings account at the end of your loan term.  Someone trying to build credit could use a credit-builder loan in conjunction with a secured credit card.  There’s no rule that that says you can’t use both. 

Credit Builder Loans – Bottom line

A credit-builder loan can be a great tool to build credit from scratch or improve low credit scores.  Take the time necessary to find the right lender and understand the loan terms.  Also, never make a late payment, or you’ll shoot yourself in the foot and undermine your credit-improvement efforts.

Before you take out a credit builder loan

  • Learn the specifics. What’s the interest rate, and how much interest will you end up paying? Will you need to put up collateral, and how much? What are the monthly payment amounts? How long will you be making payments? Is there any flexibility?
  • Verify the lender will report your payment activity – Make sure your lender is reporting to the three major credit bureaus, which they are obligated to do. After all, improving credit is the whole point.
  • Find the best option – Take time to find the best option for you. Credit builder loans can be a great way to show lenders that you can pay down a loan responsibly. A better credit history will open doors for bigger and better financial opportunities.
  • Read the fine print – As with any financial product, its important to know what you’re signing up for. There may be fees involved with applying for a credit-builder loan, reducing the amount of money you end up saving.


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