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What Is a Credit-Builder Loan?

What Is a Credit-Builder Loan

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Margaret Wack
Updated October 6, 2022
3 Min Read

If you have poor credit or a limited credit history, it can be difficult to know where to begin raising your score. Without good credit, it’s more difficult to qualify for financial products like personal loans, auto loans, credit cards, and mortgages. In some cases, poor credit may even affect borrowers’ abilities to get a job or rent an apartment.

A credit-builder loan is one way that borrowers who find it difficult to qualify for other loans or cards may begin to rebuild their score. While it’s not the best fit for borrowers who are able to qualify for other financial products, it can help those with poor credit or no credit history to establish a record of responsible borrowing and on-time monthly payments.

How does a credit-builder loan work?

A credit-builder loan is similar to a regular personal loan, but the borrower doesn’t receive funds up front and pay them back over time. Instead, the order is reversed – when borrowers take out a credit-builder loan from a lender, the funds are held in a secure account. The borrower must then make on-time monthly payments until the loan is paid off. Once the loan is paid off, they gain access to the funds.

The primary purpose of credit-builder loans is to improve borrower credit. Individuals with bad credit or those who don’t have any prior credit history may be a good fit for this type of loan. The loan amounts are generally small, usually between $300 and $1,000. Term lengths range from six months to two years.

Credit-builder loans don’t offer many benefits besides helping borrowers rebuild their scores. Borrowers who qualify may want to consider a secured credit card as an additional means of building credit.

How to get a credit-builder loan

To get a credit-builder loan, you’ll need to apply online or in-person at a bank or lender that offers this financial product. Smaller banks and credit unions tend to be more likely to offer credit-builder loans. When applying, be sure to have relevant documents handy, like your ID and social security number.

How much does a credit-builder loan cost?

The cost of a credit-builder loan varies depending on the particular lender. Some lenders charge borrowers an initial administrative fee in order to process the loan. Most credit builder loans also accumulate interest over the course of the loan. This means that, while you’re paying the loan, it will continue to earn interest until you pay it off entirely. Again, interest rates vary by lender, so it’s a good idea to shop around to ensure you’re getting the best rates possible.

Alternative ways to build credit

A credit-builder loan isn’t the only way to build your credit score. Some other options include secured credit cards, being added as an authorized user to another person’s card, paying down existing debt, and taking out other loans or credit cards.

Secured credit cards

Like credit-builder loans, secured credit cards tend to be easier for many borrowers to qualify for. They require a refundable security deposit up front, after which borrowers can spend up to that security deposit on the card.

Unlike secured loans, there’s no term limit, so borrowers can continue to use the card. In some cases, borrowers who apply for secured cards may even be eligible to turn the card into a traditional credit card and receive their deposit back in just a few months.

Get added as an authorized user

Being added as an authorized user is another easy way to boost your score. You can get your parents, significant other, or another family or friend to add you to their account. Just remember not to use the card without their permission, as racking up too high a balance can hurt their credit, too.

Pay off debt

A history of on-time payments is one element of your credit score that credit-builder loans can help with. But it can also help to pay down existing debt balances. This can reduce your overall credit utilization, which is a positive sign to lenders that you’re a responsible borrower.

Other financial products

Credit-builder loans are designed for borrowers with poor credit or no credit history. However, if you can qualify for other financial products, like loans or credit cards, these could further boost your score. Opening up a new credit card or taking out a loan may have a positive impact on your credit. However, it’s important to keep in mind that, because everyone’s credit variables are different, a new account may not always boost your score.