Explore Credit Builder Offers
Stuck with no credit or bad credit? Credit builder offers can help you turn things around, giving you the chance to build the solid credit history you need for bigger financial moves.
Credit builder loan: What it is & how to qualify
America runs on credit. Your credit history can determine everything from whether you can get a credit card or a personal loan to where you can live. Frustratingly, the very things that could build credit, like a credit-building card, require you to already have credit. So if you need credit to build credit, how do you build it if you have little to no credit history?
A credit builder loan could be a good option. This type of loan is designed to help people who are starting from scratch beef up their credit. These loans typically don’t require a credit history, making them an easier option to obtain than a credit-building credit card. Today, let’s discuss credit building loans, how they work, and how to know if one is right for you.
What is a credit builder loan?
A credit builder loan is a small loan meant to help you establish your credit history and boost your credit score over time.
As you make timely payments, the lender will report them to at least one major credit bureau, if not all three (Equifax, Experian, and TransUnion).
Payment history makes the biggest impact—up to 35%!—of your credit score. Building a positive payment history shows current and potential lenders that you’re trustworthy and capable of managing a credit account, which is proven to boost your credit score over time.
How does a credit builder loan work?
Credit builder loans work a little differently than a traditional loan.
With a traditional loan, you receive the money upfront and pay it back over time. With a credit building loan, the lender will keep the full loan amount upfront in a locked, interest-bearing account (savings, CD, or credit reserve) while you make payments.
Lenders hold onto the money in a locked account because it’s a kind of safety net, since they’re taking on risk if you have no or a low credit score.
Once you’ve paid it off, the full loan amount will be released to you—and that money is yours to do as you please! Start an emergency fund or put it towards another savings goal.
Credit builder loans vs personal loans
Here’s a breakdown of the differences between credit builder loans and personal loans.
Credit builder loan | Personal loan | |
|---|---|---|
What’s the purpose? | To build or boost credit for those who have little to no credit history | Many purposes; can be used to consolidate debt or make large purchases |
When do you see the loan money? | After you finish repayments | Directly upon approval |
What are the costs associated with the loan? | Interest and fees, although some loans will refund interest when you pay off your loan | Interest and fees, generally non-refundable; can incur origination or late-payment fees |
How much can you take out and what time frame? | Loans range from $300 to $1,000 and repayment terms generally span from 6 to 24 months | Varies greatly. Loans can range from $250 to over $100,000 and repayment terms generally span 24 to 60 months |
How does approval work? | Easier to qualify as these loans are low-risk for lenders because they keep your loan money until you pay it back | Typically requires credit checks and qualifying for the personal loan requirements. Difficult to obtain with a low credit score |
Who could benefit from a credit builder loan?
There are three groups of people who could benefit the most from a credit builder loan:
Individuals who are “credit invisible”
Those who are just starting out and don’t have a credit score or profile yet, or only have a small amount of credit history (sometimes referred to as “limited” or “thin” credit.”)
People rebuilding credit
Individuals who have had credit problems in the past and are working to improve their financial situation. This is why you will see some credit building loans called “Second Chance” loans.
Young adults
Those transitioning from being financially dependent on their parents to becoming independent. Many credit builder loans have names like “the Fresh Start loan” targeted towards this demographic.
According to an Experian and Oliver Wyman report, 28 million adult Americans are “credit invisible” and 21 million are considered “unscorable” because of their limited credit profiles.
This is where a solution like a credit builder loan could help.
Credit builder loan pros and cons
Let’s take a look at some of the common pros and cons of using a credit building loan.
Pros of credit builder loans
- Can help you establish credit history: Helps build or rebuild credit for those with limited or damaged credit. Establishes a positive payment history for credit lenders, which can help boost your credit score.
- Potential to help you improve your credit score: Consistent on-time payments are proven to boost your credit score over time. Raising your credit score can give you better chances for not only qualifying for credit, but also receiving the best rates, which can help you save money over time.
- Relatively low risk: Because the money is held in a secured account, loans to establish credit are a relatively low-risk option for lenders. That’s why they’re more likely to give these types of loans to individuals with thin credit files.
- Predictable payments: Fixed interest rates and regular payments can be helpful for budgeting.
Cons of credit builder loans
- Higher interest rates:Interest rates may be higher compared to other types of loans. This is because lenders often have little or no credit history to judge your creditworthiness, so they offset this increased risk with higher interest rates.
- Limited credit limit: Initial credit limits are typically low, with most ranging from $300-$1,000.
- You may not get your loan proceeds upfront: Credit builder loans are different from personal loans. Because lenders are taking a risk, they hold the full loan amount in a secured account that often will accrue interest while you make your on-time payments. Once you’ve paid the full loan amount, the loan amount and any interest earned will be released to you, and then that money will be 100% yours.
How to choose the best credit builder loan and build credit
It’s always good practice to shop around for the best credit building loan before you make your decision. Here’s what to consider.
Decide how much of a credit builder loan you need
As you compare offers, make sure you can comfortably afford the monthly payments, including any additional monthly fees. Stretching your budget too far and paying late can harm your credit score.
While many lenders offer up to $1,000, you can request a lower amount than that.
Compare interest rates, fees, and terms
As you shop and compare offers, look for credit builder loans with no hard credit check, which can lower your credit score.
Fixed interest rates are often appealing. Be sure to note whether a loan incurs origination fees, late payment penalties, or other charges.
Finally, consider the length of the loan term and the repayment schedule—do you prefer to make larger monthly payments to pay it off faster, or pay it back low and slow?
Double check the lender reports to credit bureaus
Does the lender report payments to all three major credit bureaus? Some only report to just two, one—or none at all. The more visibility credit bureaus have into your on-time payments, the more likely those payments will help boost your credit score.
Stay on top of payments
Ensure that the lender has a seamless way to make payments, and make sure you pay the loan as agreed. Payments that are more than 30 days late can seriously hurt your credit score. If you fall behind, talk to your lender.
Monitor your credit score
Sign up for Credit Monitoring with a personal finance app, like MoneyLion, and keep an eye on your score. Don’t stress about tiny dips, but watch the general trend of your score—it should be going upwards!
4 Alternatives to credit builder loans
Credit builder loans aren’t the only way to build credit if you have a low or no credit score. Here are some alternative options:
1. Secured credit cards
Similar to a credit builder loan, a secured credit card is backed by collateral. That means you have to put money down in the form of a deposit to open the card. The bank or credit card company then issues you a line of credit that’s equal to the amount that you put down. For example, if you put down $500 to open a secured card, you can make up to $500 worth of purchases with your new card. It’s considered low-risk for the credit card company because they can keep your deposit if you stop paying your bills.
Beyond that, a secured card works exactly the same as any other credit card, and can also help you build credit.
2. Become an authorized user
If you have a trusted relative or friend with excellent credit, they can add you as an authorized user on a credit card. The primary user doesn’t have to give you the card, and you don’t need to make any charges—just having your name attached to the account history of the card will go on your credit report and can help boost your credit.
3. Ask your landlord to report your rent
Reporting your rent can help boost your credit score by adding positive payment history to your credit report. This can be a great way to build credit without taking on any new debt. Not all landlords or property management companies offer this, but you can use third-party services to report your rent if needed!
4. Focus on paying down your current debts
Paying off debt over time can improve your payment history, and it can significantly boost your credit score by lowering your credit utilization ratio—AKA, the amount of credit you're using compared to your credit limits. The lower your balances, the better it looks to lenders, as it shows you're managing your debt responsibly.
How do credit builder loans help my credit score?