What Is a Credit Builder Loan? How It Works and Why It Matters

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A credit builder loan is an account offered by some banks, credit unions and other financial institutions that help you repair or build credit history. Those who have a hard time being approved for things like credit cards may find credit builder loans extremely helpful.

Here’s more about what is a credit builder loan — and how it can improve your credit score.

How Does a Credit Builder Loan Work?

A credit builder loan doesn’t work like a typical loan. Instead, it works similar to a secured loan. With a standard loan, the bank doesn’t give you money upfront that you can spend as you like.

Your credot builder loan is kept in a special savings account. You’ll be charged monthly for it. When you make a payment, the lender reports those good habits to the credit bureau, which builds your credit. Credit builder loans often have repayment terms that last between six months and two years.

You can access the money once you pay off the loan. In other words, you can withdraw the money you’ve paid over the duration of the loan, minus any interest.

Who Should Consider a Credit Builder Loan?

If you can’t seem to lock down an approval for a credit card, loan or other tool that allows you to bolster your credit profile, a credit builder loan may be your best shot. This may include those with limited credit history, young adults, for example, or those who have made mistakes with credit in the past and find themselves with a low credit score.

Some benefits of credit builder loans include:

• Easier approvals thanks to relaxed qualification requirements
• Building credit with healthy activity
• Forming responsible financial habits through
• Automating your savings

Keep in Mind

You’ll receive the principal you’ve contributed at the end of the loan term.

Downsides To Be Aware Of

When you choose a credit builder loan, there can be some cons to consider. Take a look at these:

You’ll Pay Interest

Most credit builder loans charge interest — meaning you’ll have to pay for the privilege of building your credit. That’s not ideal, but it could be worth the price tag if you can’t build credit any other way.

Building Good Credit History Isn’t Guaranteed

A credit builder loan account doesn’t guarantee you’ll build a good credit history. If you’re late on payments or default, your credit history will still show you’ve had some missteps with your credit in the past. That can actually be worse than having no credit history. As long as you treat it responsibly, you’ll improve your credit score, though it can take time — possibly six months or more.

Funds Aren’t Given Upfront

Again, you don’t receive any funds upfront in the same way you’d expect for a traditional loan. This account has nothing to do with spending money before you have it.

Where Can You Get a Credit Builder Loan?

You typically can’t get a credit builder loan from major banks like Chase and American Express®.

Instead, you’ll often find them from select community banks, credit unions and online lenders like Self.

Alternative Ways To Build Credit

If you aren’t in the mood to literally pay to build your credit, there are a handful of other ways you can do it. These include:

• Secured credit cards: You’ll submit a refundable security deposit, which often dictates your card’s credit limit. These are easier to be approved for, as the bank can simply use your money to pay off your debt if you default.
• Become an authorized user: If you’ve got a family member or friend with good credit, you can ride their coattails to solid credit. When they add you as an authorized user, many banks will report their good credit habits to your credit score.
• Rent reporting services: Some companies, such as Self and Boom, will report your on-time rent payments to credit bureaus to show that you can pay recurring bills on-time. This is great if you don’t have another type of revolving line, like a credit card, that you pay off each month. 
• Credit-builder apps or tools: Not unlike some rent reporting services, there are credit-builder apps/fintech platforms that report activity, such as your utility payments, streaming or subscription payments, phone payments, etc. — for example, Experian Boost.

How To Choose the Right Credit Builder Loan

The best credit builder loan helps diversify your credit profile and is easy to manage.

Look for Low Fees

Find a lender that offers a payment plan you can afford. Yes, you’re getting your money back as soon as the loan is paid off, but you still shouldn’t make large payments that you can’t swing.

Steer Clear of Long Repayment Terms

It’s also typically wise to avoid loans with lengthy terms, as you may qualify for other loans and lines of credit in six months or so. Remember, a credit builder loan is just training wheels until you achieve fair credit.

Ensure Your Lender Reports to the Major Bureaus

Finally, it’s best if your lender reports your positive activity to all three major credit bureaus: Experian, TransUnion and Equifax. This guarantees your future lenders will see your good habits, no matter which credit bureau they use to pull your credit report.

Editorial Note: This content is not provided by any entity covered in this article. Any opinions, analyses, reviews, ratings or recommendations expressed in this article are those of the author alone and have not been reviewed, approved or otherwise endorsed by any entity named in this article.

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