Credit-builder loans are specifically designed to help borrowers with a negative, limited, or nonexistent credit history to build their credit. When you take out a credit-builder loan, the payments you make help you create a history of on-time payments. Unlike traditional loans, you don’t get the money from the loan itself until you’re done paying it off.
With a credit-builder loan, you typically don’t get the money until after you make all of the payments. Instead, the lender will put the funds in a locked savings account, and they’re disbursed after you’ve made the final payment. Depending on the lender, they’ll deposit the money in your account after each payment, or they’ll wait until you’ve paid in full. The terms for credit-builder loans are usually between six and 24 months.
This differs substantially from a traditional loan, where you generally have the full amount disbursed to you before you make any payments. Credit-builder loans are less risky for lenders since they hold on to the funds until the borrower makes all their payments. For a borrower, a credit-builder loan offers an opportunity to create or boost their credit score — and when the loan is fully paid off, they end up with a nice savings balance.
Another way that credit-builder loans differ from traditional loans is that by their very nature, you can qualify with a low credit score or no credit score. However, lenders will still look at your employment, your income, and your banking history, as well as your other debts, to determine whether you’re capable of making the payments.
| For example: You might apply and receive a credit-builder loan for $600 with a 15% interest rate. Over the life of the loan, you’ll make 12 monthly payments of about $54 — the principal payment of $50, plus interest. When you’re approved for the loan, and the bank opens the account, it’ll move the $600 to a locked account, and every time you make a payment, it’ll move $50 to your savings account. At the end of the 12 months, you’ll have $600 in your savings account — if you haven’t touched it — and have 12 months of on-time payments reflected in your credit score. |
How much and how quickly a credit-builder loan improves your credit score will depend on a variety of factors, including if you make your payments on time, whether you already have a credit score or not, and other elements of your financial picture.
| Good to know: In a 2019 study, those who took out a credit-building loan saw improvements to their credit score compared to those who didn’t take out a credit-building loan six months into the loan term, according to the National Bureau of Economic Research. |
A variety of lenders offer credit-builder loans, but some of the most common places to find these financial products are community banks, credit unions, and online lenders. When looking for a credit-builder loan, keep these things in mind:
Here are three lenders that offer credit-builder loans to give you a sense of the terms you might find on the market.
| Lender | Loan facts |
|---|---|
| Ridgewood Savings Bank | |
| Digital Federal Credit Union | |
| Self |
A credit-builder loan can help you save money and boost your credit history, but here are some things to consider first:
Pros
Cons
Overall, the study found that credit-builder loans are best for borrowers with no credit history or a very limited credit file, and for borrowers who don’t have any existing debt. Opening a credit-builder loan boosted credit scores by up to 60 points for those who didn’t already carry debt — an “economically meaningful change.”
The process of getting a credit-builder loan is similar to getting any other personal loan. Here’s what you can expect:
It’s clear that a successful outcome from a credit-builder loan depends on making your monthly payments on time and in full. One of the most commonly used credit scores, the FICO score, uses five different data points to determine your score — payment history makes up 35% of your score and is the most important factor.
Here are a couple of tips to manage your credit-builder loan:
If you don’t make your payments on time, you can actually damage your credit history while losing money in interest and fees. Set yourself up for success before you sign on the dotted line.
A credit-builder loan is a good tool to create a positive payment history and boost your credit score, but it’s not the only way to do so. Here are some other options that can help:
Yes, you can get a credit-builder loan after bankruptcy — these loans are designed to help people with negative or nonexistent credit histories build or boost their credit scores. Lenders will likely review your employment history and income to determine if you’re a good candidate for a credit-builder loan.
Credit takes time to build, and FICO, one of the most popular credit scoring systems, notes that you can expect it to take about six months after taking out the loan to get a score.
There are credit-builder loans designed for small businesses. Make sure that the terms work for you.
You’ll need to review the terms of the loan to ensure there are no fees or other penalties involved with paying off your credit-builder loan early, but there are other downsides. The purpose of a credit-builder loan is for you to establish a history of on-time payments, and paying off the loan ahead of time will defeat that purpose.