Skip to content Skip to footer

A Complete Overview: Credit Builder Loan

Credit-Builder Loan

Establishing a credit score is a challenging thing to do, especially since many banks require you to have a credit history to even open an account. This makes it hard for people with no credit scores to obtain various forms of credit like credit cards or loans. However, there are some alternative options. 

One of the best ways to establish or rebuild your credit score is to apply for a credit builder loan. A credit-builder loan doesn’t require good credit for approval. In fact, this type of loan is particularly designed to help your build credit as you make payments towards a loan. 

However, similar to other types of loans, a credit builder loan requires you to pay interest throughout the duration of your loan. But some lenders do reimburse you for some of the cost after you repay the loan. 

While you don’t really need a good credit score for approval. You are still required to have enough income to make monthly payments according to the amount of the loan. At the time of applying, you might have to provide documents like your employment history, income, and balance in your checking or deposit accounts. 

In this blog, we will provide an in-depth overview of Credit-builder loans. 

What is a Credit Builder Loan?

A credit builder loan is not like a typical loan. It is a type of personal loan to build credit. Instead of receiving money upfront, the lender deposits the amount of the loan into a savings or CD account that can’t be accessed until the loan is still repaid. You get access to the loan amount when you repay the entire loan(instead of getting the money first and repaying the later). However, to avail of the loan, you might have to pay a one-time administration fee at the time of the deposit. 

The process for applying for a credit building loan is as follows- 

Setting aside the money-

The lender will set up a savings account or a certificate of deposit equal to the loan amount. Depending on the loan type and the lender, your loan may or may not earn interest. 

Making Monthly Payments-

You will have to make payments in installments towards the loan over the course of the loan tenure. (typically 6 to 24 months). 

The lender reports the payments to the credit bureau-

Your lender will report the details of your payments to at least one of the three credit bureaus every month. 

Access to the money-

If you have successfully made payments till the end of your loan’s tenure, the lender will provide you with access to your funds. 

Similar to secured credit cards, credit-building loans hold money in the bank as collateral. This makes it a less risky option for lenders since you have to save up the money before you can access it. While this might seem backward to some people, keep in mind that the sole objective of a credit builders loan is to demonstrate your ability to make timely payments. 

Once all the payments are made, you receive the loan amount that you originally put into the savings account with a portion of the interest. 

Where to Find a Credit Builder Loan?

Credit builders loans aren’t as common as typical loans. However, there are still many financial institutions and online lenders that offer credit-building loan services. 

Credit Unions and Community Banks

If you are already connected to a credit union, community bank, or any other local financial institution, you can contact them to check if credit building loans are available. You can also find local lenders by searching online for “credit builder loan” in your particular city or state. 

Community Development Financial Institutions

Community Development Financial Institutions or CDFIs are private financial institutions that are committed to providing affordable loans and other financial services to low-income and poverty-stricken members of a community. You can visit the Community Finance Network’s CDFI locator to find a location near you. 

Lending Circles

Another common option for availing of a credit-building loan is lending circles. A lending circle is a group of people who come together to lend financial assistance to each other. Six to 12 members each make monthly payments and a different member receives the loan amount each month. Formalized lending circles supported by the Mission Asset Fund report the payments to credit bureaus, making it one of the best personal loans to build credit. 

Online Lenders

Besides community-based lending options and financial institutions, borrowers looking to improve their credit score can also take advantage of several online services that specialize in helping customers increase their credit worth. 

What to Consider in a Credit Building Loan?

As mentioned above, credit builder loans are generally offered by small financial institutions like credit unions, community banks, lending circles, etc. Two of the best options include Digital Federal Credit Union and 1st Financial Federal Credit Union which offer low-interest rates and the ability to receive a refund on paid interest. Most major banks like Citi and Chase generally don’t provide credit-building loans. 

However, if you are looking for a credit builders loan, you should browse around and compare various options online. Consider the following factors to make an informed choice- 

Administrative Fee- Check whether opening a credit-building loan will incur an administrative fee, roughly around $9 to $25. 

Loan Size- It is important to consider how much money you can comfortably put into a CD or savings account as you will be unable to access the money for the remainder of the loan tenure.

Monthly Payments- Make sure to consider the amount of monthly installments that you can afford. It goes without saying that the bigger the loan, the higher the monthly installments. 

APR- Generally, credit building loans incur fixed interest of around 5% to 16%, depending on the size and lender of the loan. For example- Digital Federal Credit Union charges APR as low as 5% while self charges a higher APR of 16%. 

Interest Charges- In credit building loans, some lenders even offer you a refund of a portion of your interest. For instance- the 1st Financial Federal Credit Union refunds 50% of interest after you pay each installment on time. 

Read Also:- 5 Major Factors That Affect Your Credit Score

How Can a Credit Builder Loan Help Build Credit?

A credit-building loan is an opportunity for you to show that you are able to make consistent monthly payments on time without any hassle. Whether you are building your credit from scratch or rebuilding your credit score, credit-building loans are essential because your payment history is one of the most important factors in calculating your credit score. 

However, a credit building loan is like a double-edged sword, if you make late payments or miss payments, the lender will inform the credit bureau which will eventually hurt your credit score. 

Is Credit Building Loan a Viable Idea?

The usefulness of a credit building loan is determined by the financial condition of the borrower. According to the CFPB, credit builder loan may be beneficial to borrowers without a credit score or someone without no existing debt. 

Moreover, it is not especially a useful option for people who have outstanding debt. People with existing debt may consider paying off other loans before applying for a credit builder loan or choosing other services or products that may help them build credit. 

Telegram Banner

Tips for Managing a Credit Building Loan

If you are considering applying for a credit building loan, make sure to consider the following tips before committing to a lender- 

Understand the Terms of the Loan

Make sure to review the terms and conditions of the personal loan to build credit before signing the documents. This includes understanding the duration of the loan, APR, monthly installments, and due dates. This is essential to make sure you don’t miss your payments and comply with every loan requirement. 

Moreover, there are other complex conditions like prepayment penalties, refund of interest payments, etc. You can also confirm with the lender if they will report your payments to the concerned credit authorities or not. 

Borrow What You Can Afford

While credit-building loans don’t offer high limits( typically between $300 to $3000), it is still important to ensure you only borrow what you can afford. It goes without saying that larger credit loans require bigger monthly installments. It is the borrowers’ responsibility to understand their monthly installments before committing to a lender. 

Since the objective of a credit-building loan is to demonstrate your ability to make timely payments, borrowing too much can hamper your credit history if you fail to make payments. 

Ensure Timely and Full Payments

Generally, payments that are more than 30 days late are reported to the concerned authorities and negatively impact your credit score. A borrower’s payment history is responsible for around 35% of their FICO credit score. Your credit score will only increase if you make timely full payments towards your credit builder loan. 

As soon as your loan is approved, take the necessary steps to ensure that you don’t miss any payments. You can also set up automatic payments from your primary bank account or simply set a reminder on the installment’s due date. 

Alternative Ways to Build and Rebuild Credit

If you want to rebuild your credit and are looking for an alternative way, fret not. A credit building loan is just one option, there are several other options that allow you to build and rebuild your credit score without much hassle. If a personal loan to build credit doesn’t suit your needs, you can consider the following options- 

Secured Credit Cards

Similar to unsecured credit cards, secured credit cards also provide you with a line of credit upfront that can be used to make purchases. However, unlike an unsecured credit card, you are required to pay a security deposit in order to open an account and get a secured credit card. 

Another important thing to note is that sometimes the security deposit is refundable and many secured cards don’t charge any annual fee. You can earn back your security deposit in the form of statement credit if you use your credit card responsibly. Otherwise, it will be refunded to you when you pay all your dues and close your account. 

The Platinum Secured card from Capital One is one of the best options as it doesn’t charge any annual fee and can be opened with a security deposit of as low as $49, $99, or $200. 

Act as an Authorized User

Another great option to increase your credit score is to become an authorized user on someone else’s credit card. This will allow you to make payments via the card but the primary cardholder will be solely responsible for payments. Their responsible use can help you build your credit and improve your overall scores. Moreover, there’s no credit check or documentation to become an authorized user. 

However, make sure that the card issuer reports authorized users to the credit bureau or it won’t influence your credit score. You won’t be able to increase your credit score if the card issuer doesn’t report authorized user activity to the credit bureau. 

Secured Loan

You may be able to qualify for a personal loan even if you have no credit score depending on the lender. However, your options may be limited if you have a poor credit score. For example- you may only qualify for a secured loan which required collateral. You could also lose your collateral if you miss payments. Moreover, some personal loans such as payday loans come with high risks that don’t help in improving your credit. 

Personal Loan with Co-signer

A co-signer is another person that provides a guarantee that someone else’s debts will be repaid in time. The co-signer generally has a higher credit score than the applicant, making it easier for borrowers with low credit scores to get loans. Once your personal loan is approved, you can improve your credit score by making timely full payments and keeping your credit utilization to a minimum. 

Linkdin-Banner-YMW

Key Takeaways

  • A credit builder loan provides the borrower with an opportunity to demonstrate that they can handle making payments on time consistently. Since payment history is an important factor in calculating credit history, it helps in building your overall credit score. 
  • Credit builder loans are typically provided by community banks, lender circles, local credit unions, and financial technology companies. 
  • Although a credit builder loan doesn’t require a good credit score, you may be required to pay a fee upfront. 
  • These loans can also be used to build up savings over time. Once all the payments are made, the lender provides the full amount to the borrower who can use it as they please. 
  • Most loans are between $300 to $3000 with a duration of 6 to 24 months. The annual percentage rate and the annual fee will also vary depending on the financial institution. 

Read Also:- How to Get a Student Loan? Everything You Need to Know!

Final Words

While credit builder loans assist you in building and rebuilding credit, it is still not a suitable option for credit amateurs as they require various fees and don’t allow the borrower to access the money until the full amount is paid. Before you opt for a credit builder account, consider alternative options like becoming an authorized user on a family member’s credit card or opening a secured card account. 

Secured cards allow you to deposit money and receive an extension of the credit equal to the full amount. Whereas, a credit builder loan doesn’t allow access to the funds until the whole amount is paid in full. 

Frequently Asked Questions(FAQs)

Q.1 Can I pay off a credit-builder loan early?

Ans. Unless there are early withdrawal fees or prepayment penalties, most lenders let borrowers pay off credit loans early. However, this destroys the purpose of the loan which is to demonstrate that you are able to make payments timely. However, you can still settle this early if you are in emergency need of funds. 

Q.2 How many credit builder loans should I have?

Ans. You should only have as many credit building loans as you can handle the payments of. Since missing a payment can negatively impact your credit score. Some credit lenders also have guidelines on how many credit-builder loans you can open at a time so make sure to read the terms and conditions before opting for multiple credit building loans. 

Q.3 How can you use credit cards to build credit?

Ans. Two of the best methods to improve your credit score are to keep your credit balances low and make on-time payments on credit cards.