If you’ve never had any credit before, or are recovering from bad credit, consider taking out a credit builder loan. It’s a loan specifically designed for people who may not qualify for traditional financing, such as a credit card or personal loan.
There are a few restrictions, but they can be an easy way to build credit history without a credit card. No matter what type of financial background you have, a credit builder loan could be the solution you’re looking for.
Keep reading to find out how they can help build credit and how you can qualify for one.
What is a credit builder loan?
Also known as a “starting over loan” or a “fresh start loan,” it helps you build credit while borrowing cash.
It’s similar to a secured credit card, except you don’t need money up front to act as a security deposit. Instead, you receive the loan amount, but you must repay the loan and interest in full before you can actually access the cash.
It’s a safe transaction for both of you because you don’t risk ruining your credit any further and the bank doesn’t lose any money if you don’t repay the loan. Plus, your on-time payments are reported to the credit bureaus, helping to improve your credit scores over time.
When You Should Get a Credit Builder Loan
Because credit builder loans typically have that holding period where you can’t access your funds right away, it’s not a great choice for a financial emergency that requires immediate cash. However, if you know you need to save up for a major purchase and want to build credit, then it could be an excellent choice for you.
With a better credit score, you’ll be able to get lower rates on larger loans or credit cards in the future. By making interest payments on a small amount now, you can save money in the long run when you need to borrow money for a larger purchase.
How do credit builder loans work?
With a credit builder loan, you borrow a specific amount of money, but you are not given access to the funds. Instead, the money is deposited into a savings account as collateral. Once you begin making payments on the loan, they will be reported to the credit bureaus. If you make the payments on time, it will help you build your credit score.
Where can I get a credit builder loan?
These loans are usually found at smaller financial institutions like a community bank or credit union. They may not be advertised, so it’s best to call around and ask if they’re available.
Start with a local bank or credit union that you’re a member of.
Some local credit unions may have certain employment requirements, but many just require you to live in a certain area. Many credit unions across the country allow you to become a member by making a low, one-time contribution to a non-profit organization of their choice. It’s a quick and easy way to get access to specialized financial products like a credit builder loan.
You can also compare loan terms from certain lenders online. Self, for example, allows you to take out a loan in increments ranging from $550 to $2,200. The money is held in a CD account and earns interest while you make monthly payments for a year. Read our full review of them here.
Your payment includes both principal and interest on the loan amount. Once you repay the entire loan, you get the money from the CD account, plus the interest that earned over the year.
It won’t be enough to cover the interest you paid for the loan, but it does give you a full year of positive payment history on your credit report. If you don’t finish paying off the loan for some reason, you’ll receive the balance of the money in the account, with your outstanding loan balance subtracted from that amount. Check out other online options to compare loan amounts and interest rates.
How can you qualify for a credit builder loan?
Qualification standards vary depending on the lender you choose. However, there are a few things you can count on no matter where you go. First of all, you’ll need to be at least 18 years old and have a valid social security number. If you go with a traditional lender like a credit union or bank, you may need some type of account with them.
If you choose a credit union, you’ll have to join based on their individual membership guidelines. Otherwise, you’ll likely just need some type of banking account or debit card for the bank to reference.
While a strong credit score or credit history obviously aren’t required to qualify, many lenders do have other credit-related requirements. For example, they may not allow you to have had any entries in ChexSystems within the last six months. This refers to any type of unsavory past with a financial institution, such as excessive overdraft fees, check fraud, or unpaid fees.
If you’ve never had a problem with ChexSystems, then you should be just fine. If you have, you may need to wait a while before your ChexSystems report ages a bit more. Check with your local loan officer or online with your lender to find out any other requirements. Most approval processes are easy, taking just minutes when you apply online.
What to Consider
First, remember that this is not a quick-cash solution. If you need money immediately, find a different financial product. Next, consider how much money you want to borrow.
Most credit builder loans have maximum amounts between $500 and $2,500. You may be able to borrow a little bit more, but that’s the general range. The exact amounts vary depending on your where you get the loan and where you live. Loan terms generally last between 12 and 24 months.
Make sure your financial situation and employment are both stable enough to take care of those payments for the duration of the loan. Another consideration is that your payments will be lower with a longer payment term, but you may end up paying more in interest over time.
Finally, make sure the lender actually reports to all three credit bureaus. If they don’t, there’s simply no reason to take out the loan. Make sure it truly works for you by establishing a lasting credit history you can leverage in the future.