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.
Credit builder loans have 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,” a credit builder loan is an installment loan that helps you build credit while borrowing cash.
A credit builder loan is similar to a secured credit card, except you don’t need money upfront to act as a security deposit. Instead, you receive the loan amount, but you must repay the loan and interest in full before accessing the cash.
Credit builder loans offer 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 three major credit bureaus, helping to improve your credit scores over time.
When You Should Get a Credit Builder Loan
Credit builder loans typically have a holding period where you can’t access your funds right away. So, it’s not like a traditional loan that you might get if you have a financial emergency. 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 better credit scores, 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 the fixed monthly payments on the loan, they will be reported to the three major credit bureaus. If you make the payments on time, it will help you build a positive credit history, which ultimately helps your credit scores.
Where can I get a credit builder loan?
Many smaller financial institutions offer credit builder loans, like community banks and credit unions. 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.
Comparing loan terms from different lenders can be done easily online. For instance, Self provides an option to borrow money for a credit builder loan in increments that range from $550 to $2,200. The loan amount is kept in a secured savings account, such as a CD, which earns interest while you make payments for a year.
Your monthly payment will cover both the principal and interest on the loan amount. At the end of the loan term, you’ll receive the money from the CD account, along with the interest earned over the year.
Keep in mind, however, that the interest earned may not fully offset what you paid for the credit builder loan. Nevertheless, the loan payments will reflect positively on your credit report, giving you a full year of positive payment history.
If, for any reason, you are unable to finish paying off the credit builder loan, you will receive the remaining balance of the money in the account, minus your outstanding loan balance. Be sure to explore other online options and compare loan amounts and interest rates before making a final decision.
If you’re interested in Self, we recommend reading our full review.
See also: 5 Best Credit Builder Loans for 2023
How can you qualify for a credit builder loan?
Qualification standards for credit builder loans vary depending on the lender you choose. However, there are a few things you can count on, regardless of where you go. First, 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 to have an 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 bank 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 awhile 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 Before Getting a Credit Builder Loan
First, remember that credit builder loans are not a quick-cash solution. Credit builder loans are strictly for building credit. So, if you need money immediately, you’ll want to go with 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 bit more, but that’s the general range. The exact amounts vary depending on 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 monthly payments for the duration of the loan term. Another consideration is that your loan payments will be lower with a longer loan term, but you may end up paying more in interest over time.
Finally, make sure the lender reports to all three credit bureaus. If they don’t, there’s simply no reason to take out a credit builder loan. Make sure it truly works for you by establishing a positive credit history you can leverage in the future.
Alternatives to Credit Builder Loans
The following are some other ways you can build or rebuild your credit, regardless of your credit history:
Secured Credit Cards
Secured credit cards are designed for people with bad or no credit history. They require a cash deposit to open and will report your payment activity to the credit bureaus, helping you to build your credit scores.
The deposit for a secured credit card is usually equal to the amount of the credit limit. So, if you need a $500 limit, you will need to make a $500 deposit.
Become an Authorized User
Ask a family member or friend with good credit to add you as an authorized user to an existing credit card account. As an authorized user, you’ll benefit from the good credit of the primary cardholder, as their entire payment history for that account will appear on your credit report.
The credit card issuer will send the primary cardholder a credit card in your name. However, they don’t actually have to give it to you, nor do you have to use it to benefit as an authorized user.
Credit unions and online lenders are often more willing to lend to people with poor credit than banks. Taking out a small loan and making payments on time can help you improve your credit score.
Whether you get an unsecured personal loan or a secured personal loan, as long as you make timely payments, and they’re reported to the credit bureaus, it will help your credit score.
Frequently Asked Questions
What are the benefits of a credit builder loan?
A credit builder loan can help you build or improve your credit score over time. It can also help you access more credit in the future. Lenders may be more likely to approve you for a loan or credit card since you’ve shown a history of making on-time payments on a credit builder loan.
How do I apply for a credit builder loan?
You can apply for a credit builder loan online or in person at a community bank or credit union. You will need to provide basic personal information, such as your name and address, income, and employment history.
What is the interest rate on a credit builder loan?
Interest is charged on credit builder loans at a fixed rate. The rate typically ranges from 5% to 16%, depending on the lender and loan size. Digital Federal Credit Union, for example, charges a low 5% APR, while Self charges up to a high 16% APR.
How much money can I borrow with a credit builder loan?
The amount you can borrow with a credit builder loan will vary depending on the lender. Generally, credit builder loans are smaller than other types of traditional loans, and often range from $500 – $2,000.
How long does it take to build credit with a credit builder loan?
How long it takes to build credit with a credit builder loan depends on several factors. Typically, it can take several months for the payments on your credit builder account to be reported to the credit bureaus and for your credit scores to be impacted.
How do I know if a credit builder loan is right for me?
A credit builder loan may be right for you if you have poor or no credit, or if you want to improve your credit scores. However, it is important to make sure you are able to make the payments on time to ensure the loan has a positive impact on your credit scores.