Credit Builder Loans: Everything You Need To Know
When you want to use credit but you don't have any credit history to begin with, you can feel like you're in a chicken or egg situation. Before banks lend money, they want to know what kind of risk a potential borrower poses.
But what if you have no credit history to speak of?
Without a track record of making payments on time, you're a blank slate to a bank—and they're likely to turn you away. Or worse yet, maybe your credit history is littered with late payments or defaulted loans.
Fortunately, there's a solution: credit builder loans.
With a credit builder loan, you can start rebuilding your credit. And if you don't have a credit history at all, a credit builder loan can help you establish one.
What is a credit builder loan?
Unlike other loans, you don't receive the loan amount up front. Instead, you pay a monthly amount into a savings account.
As you pay, the lender reports your payments to the credit bureaus, and when you've paid the loan in full, you receive the money in a lump sum, plus any interest you've earned.
Credit builder loans are typically available in small amounts, which can range anywhere from a few hundred dollars to $1,000 or more. These loans are also financed over relatively short terms—typically six months to a year, although you may see some credit builder loans that extend up to two years.
Why you might need a credit builder loan
Credit builder loans might be for you if you need to establish a credit history or rebuild one that has gone south.
For example, a new college grad who's just starting out and would like to purchase a home in a few years might want to take out a credit builder loan.
These types of loans can also work well for you if you've weathered a bankruptcy and want to work on repairing the damage to your credit score.
How does a credit builder loan work?
With traditional types of loans, you receive the cash up front and then pay it back over time.
Credit builder loans work differently.
Rather than receiving a sum in the beginning, you essentially make payments into an account—usually a savings account, but it can also be a certificate of deposit.
The idea is you will make the payments on time, and that the lender will report these on-time payments to the credit bureaus, helping to boost your credit score.
How do you get a credit builder loan?
Getting a credit builder loan is a relatively straightforward process.
1. Once you've decided to get one, your first step is to find a lender that offers them, and to make sure the lender reports all payments to the three credit bureaus: Experian, Equifax, and TransUnion.
2. From there, you need to decide how much to borrow, and to make sure your budget can comfortably accommodate the monthly payments.
3. Then, you'll need to provide all the necessary information the lender requires. Generally, this will include your name, address, and other identifying information. Because you don't need to prove good credit, however, applying for a credit builder loan is usually much less stressful than trying to get a traditional loan.
4. After you're approved, you simply make monthly payments on time over the life of the loan.
Where can you get a credit builder loan?
Not all banks or lenders offer credit builder loans, so you might have to shop around. However, you can find these loans at both brick and mortar banks as well as online.
How much does a credit builder loan cost?
As with traditional loans, the fees for credit builder loans vary depending on who you borrow from. As you shop around, ask about the following:
The good news about credit builder loans is that most are designed to be affordable and accessible for people who need to build or rebuild their credit.
Credit builder loan pros & cons
Here's a snapshot of some of the pros and cons you'll find with credit builder loans.
Easy to apply for, with no need for good credit.
Missing or running late on a payment could lower your credit score.
At the end, you get a lump sum of cash you can use however you wish.
Unless you work with a nonprofit, you'll likely pay some type of fee, as well as an APR.
Encourages you to develop a savings strategy, which you can continue long after the loan is paid off.
Many credit builder loans allow you to earn interest.
You can use the credit builder loan as a stepping stone to bigger loans for larger purchases.
Other options for building your credit
Whether you're looking to rebuild your credit or start a credit history from scratch, credit builder loans aren't the only game in town. Here are some other options for building your credit:
Secured credit cards
With a secured credit card, you give the lender collateral in the form of a down payment, which "secures" your loan and eliminates risk for the bank, which then extends you a line of credit in the same amount as your down payment.
As you use your credit card and make your monthly payments, the lender reports your on-time payments to the credit bureaus, which helps you build a credit history and improve your credit score.
Many secured credit cards allow you to convert your account to a regular, unsecured credit card after a certain period of time.
Some banks offer personal loans to consumers who wish to establish or repair their credit. While you might struggle to get accepted if your credit score is quite low, some lenders are willing to work with borrowers who have less than stellar credit.
One of the downsides to these types of loans, however, is that they typically come with higher fees and interest rates compared to credit builder loans.
If you choose this route, it's important to consider if the fees and high interest rates are worth it.
Building (or rebuilding) your credit
Repairing or establishing credit can be hard work, but there are a number of tools that can help you do it.
For many people, a credit builder loan is a straightforward, hassle-free way to get started on the path to good credit.
About the Author
Mike is a recognized credit expert and founder of Credit Takeoff. His credit advice has been featured in CNBC, Investopedia, CreditCards.com, Bankrate, Huffpost, The Simple Dollar, Reader's Digest, LendingTree, and Quickbooks. Read more.