What a Credit Builder Loan Is and How to Use It Wisely
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Without much credit history, applicants for credit cards can face a common Catch-22 when they’re denied credit: They can’t open a credit account until they have a credit history.
And they won’t have a history of using credit if they don’t have a credit card.
People just starting their financial lives can usually be approved for a credit card if they have a good job. But those without much income can have a harder time establishing credit, which can eventually make it easier to get home and auto loans and rewards credit cards.
Luckily, there are a few ways to start a credit history: a record of how long you’ve had credit accounts and if you’ve paid them on time. Credit history is the biggest factor in determining a credit score.
One option is a credit builder loan. Being approved for one doesn’t require having a credit history. Credit builder loans are primarily designed to help credit newbies establish a credit history so they can be approved for credit cards and other forms of credit.
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What is a credit builder loan?
A credit builder loan is a financial product designed to help individuals build or improve their credit scores. Unlike traditional loans, where you receive the borrowed money upfront and then make payments to pay it back, with a credit builder loan, the lender sets aside the loan amount in a secured savings account and does not release the funds to the borrower until the loan is fully paid off.
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- If you're tight on cash right now, you may want to consider getting a personal loan. A personal loan is a loan that you can use for just about any purpose like: paying off other debt, renovating your home, or family needs like a wedding or adoption.
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How a credit builder loan works
It’s going to sound backward to what a regular loan looks like, but here’s how it works:
Instead of receiving the loaned money upfront, the money you borrow in a credit builder loan is deposited into a savings account or CD that you can only access when your loan is repaid.
It sounds odd, but that’s how it works: You receive the loan money after you’ve repaid the loan. Not before.
Here's how it typically works:
- Application. You apply for a credit builder loan through a financial institution that offers them. The amount can vary but is typically between $300 and $1,000 for most credit builder loans.
- Payments. Once approved, you make regular, fixed payments over a set period, usually 6 to 24 months. The lender reports these payments to the credit bureaus (Equifax, Experian, and TransUnion).
- Credit reporting. The lender's timely payment reporting helps build your credit history. For the credit builder loan to positively affect your credit score, you must make consistent, on-time payments on the loan. And that’s the main reason to get a credit builder loan: To establish a credit history and improve your credit score. Not making timely loan payments defeats the purpose of the loan.
- Access to funds. After you've made all the payments, you have access to the total loan amount. Some lenders might also refund a portion of the interest you paid on the loan.
- Savings component. Essentially, you're saving money while building credit, as you receive the lump sum at the end of the loan term, which can then be used as you wish.
Downsides of credit builder loans
These loans are typically only for $300 to $1,000. Such a small loan can be easier to repay, but the problem is that you won’t get that loan amount until you’ve repaid it. In essence, you’re prepaying the loan before you get the money.
Like a secured credit card, the bank holds the money it will pay you as collateral.
Before taking out a credit builder loan, know your monthly payment. Make sure it’s an amount you can afford. The larger the loan, the higher the monthly payment.
The loans typically require a set-up fee of $9 to $25.
Of course, you’ll pay interest on the loan. It is usually at a fixed rate, between 5% and 16%. Some lenders may repay part of the interest charges if you make on-time payments.
Use Quicken Loans to Get a Personal Loan
- If you're tight on cash right now, you may want to consider getting a personal loan. A personal loan is a loan that you can use for just about any purpose like: paying off other debt, renovating your home, or family needs like a wedding or adoption.
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Where to get a credit builder loan and how to use it
Smaller financial institutions like credit unions, community banks, and online lenders will most likely offer credit builder loans.
Compare lenders and the options and terms that each lender offers.
The best way to use a credit builder loan is to not use the money. Remember, the purpose of the loan is to build your credit history so that the credit bureaus can see that you have a good record of paying back a loan. Lenders such as credit card providers will be more likely to offer you credit.
So, instead of immediately spending the money, once you’ve paid off the credit builder loan, you get it, set it aside, or use it for an expense you already planned.
If you can, save money for repaying the credit builder loan before you apply for it. That way, you’ll be assured of repaying the loan and won’t be in debt.
Other options
Since your ultimate goal is to establish a credit history so you can get a credit card and later use a good credit score to get a car or home loan, there are other ways to start your credit history.
One is to become an authorized user on a family member or close friend’s credit card account. Both you and the main user are responsible for repaying any charges you make, so make sure you can afford anything you buy as an authorized user.
Another option is to open a secured credit card. These cards allow you to deposit money and receive a credit amount equal to the deposit. You use the card just like any other credit card, but only up to the deposit amount used as collateral.
College students and others who don’t normally have much credit history can also apply for credit cards aimed at them. Ask your bank what types of credit cards it offers customers who don’t have much credit history.
FAQs
How do credit builder loans help improve my credit score?
Credit builder loans help improve your credit score by demonstrating your ability to make regular, on-time payments. These payments are reported to the credit bureaus, contributing positively to your payment history, which is a significant factor in your credit score calculation.
Can I get a credit builder loan with bad credit or no credit?
Yes, credit builder loans are specifically designed for individuals with bad credit or no credit history. Since the loan amount is secured and held by the lender until you've made all the payments, these loans present a lower risk to lenders and are more accessible than traditional loans.
What happens if I miss a payment on my credit builder loan?
Missing a payment can negatively impact your credit score, as the lender reports your payment history to the credit bureaus. It's crucial to make all payments on time to benefit from the credit-building aspects of the loan. Some lenders may offer a grace period or work with you to adjust your payment schedule in case of financial hardship, but it's important to communicate with your lender as soon as possible if you anticipate missing a payment.
Are there any fees associated with credit builder loans?
Credit builder loans may come with various fees, including application or origination fees and interest charges. The specific fees and interest rates can vary by lender, so it's important to review the terms and conditions carefully before applying for a credit builder loan.
How much money will I receive at the end of the credit builder loan term?
At the end of the credit builder loan term, you'll receive the total amount you paid in, minus any applicable fees and interest charged by the lender. Some lenders might offer to return a portion of the interest paid as an incentive. The exact amount you'll receive depends on the terms of your loan and the lender's policies.
Use Quicken Loans to Get a Personal Loan
- If you're tight on cash right now, you may want to consider getting a personal loan. A personal loan is a loan that you can use for just about any purpose like: paying off other debt, renovating your home, or family needs like a wedding or adoption.
- TrustPilot Rating 4.6 out of 5
- Connect with lenders for $0
- 100% online experience.
The bottom line
Credit builder loans iserve as a practical financial tool for individuals aiming to build or enhance their credit report. By functioning as an installment loan tailored for those with a low credit score, credit builder loans necessitate fixed monthly payments that are reported to major credit bureaus and other reporting agencies. This process ensures that each on-time payment contributes to a positive payment history, which is crucial for establishing or improving credit. By diligently making these payments, borrowers can demonstrate financial responsibility, leading to a positive credit standing. Consequently, credit builder loans offer a pathway for individuals to access better financial products and rates in the future, making them an invaluable option for credit improvement.
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