Credit Builder Loans 101
Is it time to establish or repair your credit? A credit builder loan might be just what you need.
What is a Credit Builder Loan?
Credit builder loans are reverse loans that are used to establish or repair credit.
Whether you’re starting out with no credit, or circumstance has negatively impacted your score, these loans are designed to help.
Credit Builder Loans Vs. Traditional Loans
There are a number of differences between credit builder and traditional loans. In brief…
With a traditional loan, you get the money upfront and are then required to pay it back in installments over a predetermined amount of time.
With a credit builder loan, however, you do not get the money until after you’ve paid off the complete balance of the loan.
Say you need $1,000 to pay for rent at the beginning of the month. If you don’t have the funds to pay, you may consider getting a personal loan. You’ll apply and, as long as you qualify, a lender will give you the money with a caveat:
– You’ll have to pay them back over a certain period of time. With interest.
Credit builder loans work in the opposite way. They are designed to build or repair your credit score, rather than to give your finances a temporary boost.
To apply for this type of loan, you need to go to a lender who will then set aside a predetermined amount into an account for you until it is paid. Once you’ve made all of the payments, the lender will either wire you the money and automatically close the account, or they will give you direct access.
Credit Builder Loans
They typically exist in smaller amounts – usually between $200 and $2,000.
The life of a loan is 6-24 months, depending on the lender.
A typical APR is 10%, but it can be lower or higher.
Opening the account requires a small, one-time fee.
You get access to the money and (sometimes) the interest AFTER you pay as agreed.
This loan helps you build credit while helping you build up a small amount of savings for future use.
You do not need to have credit to qualify.
Traditional Loans
You get the money upfront, but you then have to pay back the loan with interest.
You typically need to have credit before you can qualify. The lower your credit, the higher the interest.
These loans usually range between $1,000 and $50,000, with longer payoff periods.
If you’re interested in learning more about traditional loans, check out this post: Getting a Personal Loan with No Income Verification: The Ultimate Guide
How Exactly Do Credit Builder Loans Work?
The first step is to find a lender who offers credit builder loans. Keep in mind that not all financial institutions do.
Don’t be afraid to look around.
Tip: Google: “Credit Builder Loan” + “State”
Take a look at the lender’s terms for the loan. This includes:
Interest rates or APR (annual percentage rate)
Loan amount and length of term
Any penalties for closing the account early or missing payments
Whether or not the interest you pay will be returned to the account (dividends)
And, most importantly, make sure the lender is reporting to the three credit bureaus (Experian, TransUnion, Equifax). While you’re making your monthly, on-time payments, the lender should be reporting this information to the credit bureaus, as this will help you to repair or establish your credit.
Once you’ve found a lender and agreed to the terms, the lender will transfer the loan deposit from their side into a secure account (savings or CD) where it will stay until you’ve paid in full.
Then, just like with a traditional loan, you will make scheduled payments over the course of the loan’s life until it is done. Once paid off, the lender will either give you direct access to the money or else wire it to an account of your choosing.
In both cases, you will get the full amount in one lump sum. At that point, you are free to use the money however you see fit, provided you’re keeping things legal, of course.
Why Get a Credit Builder Loan?
Sometimes called a “Fresh Start Loan” or a “Starting Over Loan,” a credit builder loan has three purposes:
1) To establish credit when you have none.
2) To repair your credit score.
3) To help you create a small bit of savings.
These loans are not as well-known as traditional loans, but they are highly useful for people who need – or want – to build up their credit, especially when they have had a recent bout of poor credit history.
The good thing is that these loans are generally easy to qualify for. At the same time, because of the way they work you can build up some savings while building up your credit.
Who Should Get a Credit Builder Loan?
Because credit builder loans are designed for people looking to build up their credit scores, they are best for people who:
Have no credit but need it
This could be anyone. From young adults who’ve never even had a credit card to married individuals who’ve never needed to build credit until now. This could be anything from signing a new apartment lease to getting a mortgage loan.
Have poor credit
This can happen for a number of reasons, including a history of late or missed payments.
Important! Do not get a credit builder loan if you are unable to make regular, on-time payments. The only way to build or repair credit is to prove to the credit bureaus that you are reliable and able to make the payments. If you cannot at this time, do not get a loan.
Can’t I Get a Traditional Loan Instead?
While it is possible to get a typical loan or line of credit with no or poor credit, it can be much more difficult to do so. Oftentimes, you will need to pay much higher interest rates. There also tend to be more restrictions on the type of loan and what you can use it for.
Thus, a credit builder loan can be a great starting point. With it, you can build up your credit (and save in exorbitant interest rates) to a point where you can eventually apply for bigger, better things.
Why Does Credit Matter?
Anytime you want to borrow a large amount of money for something – a family vacation, a piece of property, a car, etc. –, the institution lending you the money will refer to your credit score as part of their decision to approve or reject your application for a loan.
Even if you want to rent an apartment, your credit score will be a factor in how much of a deposit you have to pay, as well as if you even get approved.
A higher credit score means:
Lower premiums (interest on loans)
A higher cap on the amount of money you can borrow (on credit cards, mortgages, personal loans, etc.)
Better insurance rates
Better rewards on credit cards
Etc.
If you ever want to borrow money, you’ll want to have good credit. The credit bureaus keep and manage your credit history in one handy place for potential lenders, employers, and landlords to access. And, while having good credit isn’t an absolute must, it provides long-term benefits to you.
How (Much) Will a Credit Builder Loan Help My Credit Score?
The purpose of a credit builder loan is to help you build up your credit, but how much it will help – and how quickly – varies greatly. After all, there are multiple factors involved when it comes to your credit score.
What impacts my credit score?
First, a quick definition of credit:
According to Experian, “credit is the ability to borrow money or access goods or services with the understanding that you’ll pay later.”
To better understand what factors into your credit score, take a look at the following image.
Credit score factors (example).
As you can see, there are 3 “high impact” areas: Payment history, credit card history, and derogatory marks.
How much do late payments impact my credit score?
Credit builder loans give you the opportunity to build your credit score through consistent, on-time payments.
Your payment history accounts for around 35% of your credit score, with the most recent payments having the greatest impact. Late payments are categorized into the following:
30/60/90/120/150 days late
Delinquent
The later the payments, the worse it is for your credit. That said, having more recent on-time payments has a greater impact on your credit score. Thus, making on-time payments is always recommended.
Remember, while it can take months or even longer to build up to a good credit score, a single missed payment of 30 days or more can bring it crashing down.
How much will my credit score increase with a credit builder loan?
Short answer: It depends.
The number of accounts (ie. loans, lines of credit) you have open, your “borrowing limit,” and the other factors mentioned previously all impact your credit score.
Credit takes time to build up, and even credit building loans can only work so fast. If you’re starting with no credit, you should see a score within the first 3-6 months of opening your account.
Keep making payments on time and maintain good financial management habits, and you should be able to reach a decent credit score before too long. Ultimately, building up your credit score can take a while, but it’ll happen.
Why do institutions lend money to people with good credit?
This is a good question.
The reason for this is that lenders see people with good credit as a lower risk to them. If you have good credit, that means you’ve made your payments on time, that you’ve consistently had accounts in good standing, and so on.
Basically, a person with good credit (670 – 799) or excellent credit (800 – 850) is considered as more reliable. This means there is less risk that they won’t pay back the loan.
When you have no credit (as opposed to bad credit), you’re an “unknown,” and lenders don’t tend to like that either.
If you’ve ever had a first job, you probably remember how hard it was to prove yourself to the potential employer without experience. The same goes for getting your first real loan. Most lenders don’t want to take a chance of handing over money to someone who may not pay it back.
But with a credit builder loan, there is no risk to the lender since they’re not actually giving you any money until you’ve paid for it. Once you’ve proven yourself to one lender, you also have a greater chance of qualifying for future loans or dealings with institutions later on.
Best Places to Get a Credit Builder Loan
Now that you’re thinking of taking steps to build or repair your credit by getting a credit builder loan, you need to know where to get one. Fortunately, you have several options.
Community banks & credit unions
Community banks and credit unions are small institutions designed to serve their local communities. With both types of financial institutions, you can be approved for a loan with poor or no credit. Keep in mind that credit unions do require you to be a member before giving you a loan, but they also tend to have the lowest interest rates.
Some options:
First Fidelity Bank (locations: AZ, OK): Their credit builder loans (which they also call “consumer loans”) are available to individuals with no credit. They provide loans with a $1,500 loan minimum, but no maximum, at a 3% fixed interest rate. Their payoff terms range from 12-24 months, based on the amount of the loan. Origination cost: $50 (financed back into the loan).
Digital Federal Credit Union (DCU): You can borrow anywhere from $500 to $3,000 with an average APR (Annual Percentage Rate) of 5%. Interest is put into the account with your loan and is returned to you upon complete repayment. Terms also range from 12 to 24 months.
Alltru Credit Union (formerly 1st Financial Federal Credit Union): The borrowing limit is $1,000 with a term of 1 year or less. The APY here is higher than the previous two at 12%, with half of it being returned to you upon successful, on-time payments.
Online lenders
Since online institutions are location-independent, this can be a great option if you’re having trouble finding a lender closer to where you live.
Self Financial, Inc.: They provide credit builder loans starting at $25 a month with a 24-month maximum term. APR ranges from 14.92% to 15.65%. There is also a one-time administrative fee of $9-15.
Fig Loans: Available in six states (FL, IL, MO, OH, TX, UT), this lender offers credit builder loans up to $600 with various repayment periods.
Lending circles (or peer community groups)
Mostly run by the not-for-profit Mission Asset Fund, lending circles consist of small groups – usually 6-12 members. In these groups, each member contributes a specified amount of money each month into a joint account. These groups work on a round robin system, meaning each month a different person will be selected to receive the money. The cycle goes on until every person in the group has received their share. Loans tend to be between $300 and $2,400 and are interest-free.
How do they work? Each time you make a payment to the lending circle, that payment is reported to the three credit bureaus, thus building up your credit score over time. Check out Mission Asset Fund’s official site for more details on how to apply.
It is always best to do your due diligence and look into any financial institution before you choose one. Check out current or previous customer reviews and overall ratings. Additionally, try to choose an institution that reports to all three credit bureaus.
Tip: You have options, so take some time and check around before deciding.
Best Banks Offering Credit Builder Loans
While most larger institutions do not offer credit builder loans, there are a few that do. Still others offer alternatives. For instance:
Wells Fargo: This bank reports that the majority of their borrowers have a credit score of 660+, and they do not offer credit builder loans specifically. However, they do have an alternative option for members with lower credit scores:
You as the borrower deposit money into a savings account of CD (Certificate of Deposit) in return for a loan or line of credit. Each on-time payment made is then reported to the credit bureaus.
Money Lion: With Money Lion, not only can you get a loan up to $1,000 without a credit check, you receive a portion of this amount straight away, much like with a traditional loan. The remainder stays in an account until you’ve paid it off. Money Lion also has a mobile app that lets you check your payment history throughout, and to automate your payments.
Best Credit Repair Alternatives
The good news is that credit builder loans are not the only option out there. Each of these 6 alternatives will help you build your credit.
Secured personal loans
Institutions may offer a secured personal loan to borrowers with no credit because the loan itself requires the borrower to put up collateral – paid-off car, home, etc. – in exchange for the loaned amount. If the borrower defaults (fails to pay) on the loan, they can lose the collateral. This takes the risk off the lender and puts it more solidly on the borrower.
Unsecured personal loans
An unsecured personal loan is likely the first thing you think of when it comes to getting a loan from a bank (or other financial institution). Lenders generally will look at the borrower’s income, credit score and general situation when deciding whether to loan them the money or not. The lower the borrower’s credit, the higher the interest rates. Because credit score matters in these unsecured loans, they can be harder to get for people with no or poor credit.
Share-backed or certificate-secured loans
This is another type of credit-building loan that uses the money already in your bank account as collateral and freezes it until you have paid back the loan. In some cases, the money in your account will slowly “thaw out” as you pay the money back, thus giving you early access to it.
Secured credit cards
Unlike a standard credit card, a secured card requires an initial cash deposit (usually at least $200-300), which can then serve as your credit limit. Over time, you can build up your credit and increase your limit. With enough on-time payments, your financial institution may provide you with the option of converting the secured card to a more traditional unsecured card with a higher limit.
Credit cards are useful in that, even if you do not actively use them, as long as any and all payments are on time and the account remains open, your lender will still report to the credit bureaus.
Authorized user
You can build up your credit by becoming an authorized user on an existing account (owned by a primary account holder). As an authorized user, you can access someone else’s credit card account and, in some cases, even get your own card that is linked to the primary account. Before deciding to go this route, make sure the primary cardholder’s credit score is good (670 – 799) or excellent (800 – 850).
As an important detail, the authorized user does not have to actually use the account at all to build credit. As long as the primary cardholder makes regular, on-time payments, it will benefit both users.
Cosign on an auto loan
Going from no credit to fair or good credit can be simple, especially if you have someone with established credit who is willing to go in on a loan with you. The downside is that cosigning with someone with poor or no credit can negatively impact the person with the better credit, at least for a while. With on-time payments, however, their score will rise – as will yours.
How Can I Manage My Credit Builder Loan?
1) Choose a loan you can comfortably pay back. By picking a loan that fits into your budget, you can ensure you pay it back each month. Pay attention to not only the amount of the loan, but the term.
2) Make sure your institution reports to all three credit bureaus. While it can help your credit to even report to just one bureau, reporting to all three allows for more consistency in establishing (or repairing) your credit.
3) Schedule your payments. Never miss a payment, and always pay a consistent amount. Slow and steady is key to building credit, after all. You can even automate them, in some cases. On top of that, a few lenders charge late fees.
4) Keep an eye on your credit score. Whether your lender has a mobile app, or you use something like Credit Karma, check in on your credit score every 2-4 weeks to make sure you’re on track. But remember, if you’re starting from no credit, it can take longer than a month to show up, so don’t worry if your score isn’t updating right away.
5) Establish financial goals for yourself. Because you’ll have a lump sum of money at the end of the loan’s term (the principal + any interest), you might want to make a plan for what to do with it. This can mean setting aside an emergency fund, reinvesting into another loan, or anything else you’d like to do.
Can I pay off my credit builder loan early?
Paying off your loan early is generally an option. However, if you are trying to build or repair your credit, it is better to make consistent payments over a period of time, rather than closing the account early.
However, if you do need to close your account early, speak to your lender about their policy (if you don’t already know it). In most cases, they will allow it. Usually, you will get the amount you’ve paid into the account back, minus the account opening fee (aka origination fee) and any interest.
Wrapping Up
When looking for a credit builder loan, the best thing to do is to first check with your current bank or credit union to see what they offer. Even if they go under another name – like “Fresh Start Loan” – or are offered in the form of a CD, it’s possible that your financial institution will have them.
If not, then a quick check online can come up with some great results. Just be sure to cross-reference them, especially when it comes to online lenders.
Before getting a credit builder loan, ask yourself if building your credit score is worth losing a little money (initial setup fee and any interest you do not get back) and having to temporarily give up access to a certain amount of your funds. When it comes to preparing for certain big financial moves – such as purchasing property -, you may find the answer is yes.
Key takeaways
Credit builder loans do not help with monthly cash flow, but they do help with long-term credit-building and increasing your savings.
Credit builder loans can help you to create good financial habits when it comes to paying your debt back in time.
On-time payments are more important than the size of the loan. Choose the amount you need based on what you can consistently pay back.
Longer loan terms equal more interest, so only sign up for an amount you can manage.
Make sure your lender reports to all three credit bureaus.
Once you have paid off your credit builder loan, you will get the money in the savings account or CD, sometimes also with the interest you’ve paid into it.
A credit builder loan allows you to build your credit up from nonexistent, or to repair poor credit.
Related reading: 524 Credit Score: All You Need to Know to Understand and Fix It