If you have poor or no credit, you may not qualify for the types of accounts—credit cards, personal loans, etc.—that could help build it. It’s one of the many frustrations of the United States’s credit system, but there are a few under-the-radar ways to improve it.
One of them is called, appropriately, a “credit builder” loan. These small installment loans are typically offered by credit unions and some banks, and they can help you boost your score a bit if you make on-time payments.
How It Works
According to NerdWallet, you may also see credit builder loans advertised as “Fresh Start Loans” or “starting Over Loans.” To take one out, you’ll need to prove that you have enough income to make on-time payments. For a “pure,” secured loan, the credit union holds the amount you borrow—typically $500 to $1,500, per CreditCards.com’s Allie Johnson—frozen in a savings account, and then you make payments each month, which are reported to Equifax, Experian and Transunion, the three major credit bureaus.
When it’s completely paid off, you also get the accrued interest. That’s what differentiates it from other types of loans, says Greg McBride, Bankrate’s chief financial analyst. It’s also why it isn’t available at every financial institution—credit unions offer them as a service to their members.
There is also an unsecured version, which gives you a small amount of money upfront, typically for an unexpected expense, and you pay it back with an automatic fund transfer. These can be a good alternative to payday loans, writes Johnson.
Payment history is the most important component of your FICO credit score, which means the reported on-time payments could help lift your score—though of course, there’s no magic bullet that will take you from, say, 550 to 750. “If you’re recovering from bankruptcy or a string of delinquencies, it’s a step in the right direction but it’s not a cure all,” says McBride.
Another important factor is your credit mix, which accounts for 10 percent of your FICO score. Adding an installment loan can help you in this area if you only have, say, one credit card.
What to Look For
If you decide this makes sense for you, you’ll want to do your homework. You don’t want to stretch yourself too thin—taking out a substantially higher loan amount isn’t worth more to credit bureaus than a lower, more manageable sum—and you want the term to be no longer than 24 months, per NerdWallet.
So make sure you know all of the details before you sign up. “Get specifics on any loan you’re considering, including how it works, whether you need to put up collateral, the interest rate, the monthly payment amount and whether payments are reported promptly to all three credit bureaus,” writes Johnson.
Again, if you can’t repay the loan in a timely manner—within 30 days of when it’s due—then you could hurt your credit even more. So it’s only something you want to do if you’re sure you can pay it off on time.
But also remember that you don’t want to rush off the payment. Building credit takes time, which is the point of the loan. So if it’s a 12-month loan, recognize that you need to make payments for 12 months for it to be most effective, even if you have the ability to pay it off sooner. If you need a quick credit fix, this isn’t for you.
Other Ways to Build Credit
If that seems complicated, here are three other ways to build your credit:
Pay off past due accounts: The collections amounts won’t be removed immediately after you repay them, but a repaid bill is viewed more favorably than a past due bill. And make sure you’re checking your score for mistakes or black marks that can be removed.
Apply for a secured credit card: “As long as you pay the balance in full every month, you don’t have to worry about interest charges,” says McBride. “But stay away from those that have big application fees and annual fees.”
Become an authorized user on a family member’s card: But remember, both of you have responsibility for payments, and both of your credit scores will be affected.
But if none of that works, there could be some recourse in a credit builder loan—particularly if you’re young and have no credit at all. Again, make sure you have the funds to pay it off on time—otherwise it’ll do more harm than good.
“It’s a good option if you’re in a situation where you’re looking to establish or rebuild your credit,” says McBride. “If the shoe fits, wear it.”