What a credit-builder loan is and how it works

A credit-builder loan is designed to help people with no credit or poor credit build a track record of on-time payments. Instead of receiving funds upfront, you make monthly payments that are reported to all three credit bureaus, and you get the money after the term ends.

Once you have a credit score and established a positive payment history, you can apply for other credit products, such as credit cards, personal loans or a mortgage. Keep in mind credit scores are important and apply to your everyday life – landlords check them for apartments, insurers use them to set rates, and some employers even review them during hiring.

How credit-builder loans work and improve credit scores

Credit-builder loans are a type of credit-building product that typically range from $300 to $1,000, though some lenders offer up to $3,000. The lender deposits this amount into a secured savings account or certificate of deposit (CD) that earns interest while you make monthly payments over 6 to 24 months. You’ll pay interest on the loan that ranges from 6 percent to 16 percent APR, and you may also have to pay an application fee ranging from $10 to $25.

While you make your payments, the lender reports your monthly payments to credit agencies, and over time, the payments may help boost a bad score or build a credit history if you don’t have a score.

For example, let’s say you take out a $1,000 credit-builder loan at 7% interest for 24 months. Your monthly payment would be approximately $45. After making all 24 payments on time, you’d receive your $1,000 back (minus any fees), and you’d have established two years of positive payment history on your credit reports.

Once you’ve made all the payments, you’ve built a satisfactory history with the lender and can access the full amount you borrowed. Some lenders may even return a portion of the interest as dividends, particularly credit unions.

Who are credit-builder loans for?

People new to credit, like recent high school or college graduates, may benefit from a credit-builder loan to help develop a credit score. According to U.S. News research, 59% of credit-invisible consumers want to build their credit, but many don’t know how or haven’t tried. Taking out a credit-builder loan could also be a wise move if you fit into one of the following categories:

Credit-invisible consumers

If you’re credit invisible, you don’t have any reported credit history, so a credit-builder loan can help add a positive payment history to your report to help you establish a credit score. According to Experian and consulting firm Oliver Wyman, over 28 million U.S. consumers don’t have any credit history, representing about 11% of the adult population. The data also shows disparities by race for credit invisibility:

• 16 percent of Hispanic consumers
• 14 percent of Black consumers
• 10 percent of Asian consumers
• 9 percent of white consumers

Thin-credit consumers

A credit-builder loan could also help if you have a thin-credit profile, which means you don’t have enough active credit history to generate a credit score. Once your payments are reported to the credit bureaus, it can beef up your credit file.

In addition to the 28 million credit-invisible consumers, an additional 21 million Americans are “unscorable.” These consumers have some experience with credit but not enough to generate a score. These groups represent nearly 50 million Americans who could benefit from credit-builder loans.

Recent Consumer Financial Protection Bureau (CFPB) data corrections reveal an even broader market for credit-builder loans. While the credit invisible population is estimated at 7 million adults as of 2020, there are an additional 25.3 million adults with unscored credit records. This means over 32 million Americans could benefit from credit-builder loans.

Where to find credit-builder loans

You can get a credit-builder loan from several places. When shopping, look for lenders that report to the three major credit bureaus to maximize your credit-building impact:

• Credit unions: Credit unions often offer lower rates than some larger banks since they are member-owned, not-for-profit institutions. You must become a credit union member before borrowing. Many credit unions offer credit-builder loans in the 5% to 10% APR range.
• Small banks: You’re less likely to find a credit-builder loan at national, big-name banks, but your community or regional bank may offer this product. Community banks often have more flexible underwriting and may work with you if you have banking history with them.
• Community Development Financial Institutions (CDFIs): These institutions, which include banks, credit unions and nonprofit funds, specialize in doing business with borrowers in underserved communities and low-income areas. There are about 1,400 CDFIs in the U.S., and you can find them through the CDFI Fund website.
• Online lenders: Some online lenders offer credit-builder loans with loan terms as long as 48 months. Popular options include Self, Chime, and MoneyLion, though not all are available in every state.

Benefits and disadvantages to credit-builder loans

While credit-builder loans can be powerful tools for establishing credit, they come with both advantages and potential drawbacks to consider:

Benefits

• No credit check required for most lenders
• Forced savings component helps you build an emergency fund
• Lower risk than traditional credit cards for building credit
• Fixed monthly payments help establish budgeting discipline
• Some lenders return interest as dividends

Disadvantages

• No access to funds until loan completion
• Interest costs (around 6% to 16% APR) mean you pay to build credit
• Application fees and administrative costs
• Missing payments damage your credit
• Not helpful for emergency expenses

Best bad credit loans

Want to check out the rates lenders are offering to people with less than ideal credit? Check out the latest rates lenders are offering.

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How to get a credit-builder loan in 6 steps

Getting a credit-builder loan is relatively easy. There are typically no credit checks involved, and you could get your account set up the same day you apply. That said, there are still a few steps to follow for you to get the most out of your loan.

1. Review your monthly budget

Don’t take on a new monthly payment unless you’ve checked your monthly spending. Remember, you don’t receive any funds up front with a credit-builder loan. Start with a small loan amount to ensure you can afford the payment and avoid a situation where you can’t repay the balance. A good rule of thumb to follow: your credit-builder loan payment shouldn’t exceed 5% of your monthly income.

2. Check your credit history

Although credit-builder loan eligibility criteria aren’t as focused on your credit scores, checking your credit history for any issues affecting your approval is a good idea. You can get a free weekly copy of your credit reports from Experian, TransUnion and Equifax by visiting AnnualCreditReport.com. Disputes may take up to 30 days to be addressed, so be sure to give yourself ample time between reviewing your report and applying.

3. Compare your options

It’s always best to shop around before you choose a credit-builder loan. Pay attention to the following when comparing lenders:

• Loan amounts: Although the amounts vary from lender to lender, most credit-builder loans are between $300 and $1,000. The more you borrow, the higher your payment will be, so starting with a smaller loan is best.
• Repayment terms: Credit-builder loan terms tend to be shorter, from 12 months to 36 months. The shorter your term, the higher your monthly payment, but the lower interest you’ll pay overall.
• Flexibility: In general, you can’t access credit-builder loan funds until you’ve made all the payments. However, some lenders may allow you to receive some of the balance after you’ve made a set number of payments.
• APRs and fees: Your monthly payment may not cover interest and fee charges. In such cases, those costs are deducted after you’ve made all of your scheduled payments, which can take a big chunk out of the funds you receive.

4. Gather all the necessary information

Credit-builder lenders usually require the same documents needed for a personal loan. The requirements may vary among lenders, but usually include:

• A picture ID, like a driver’s license or passport
• Your Social Security number and date of birth
• Your phone number, address, and email address
• Copies of paystubs, W-2s or tax returns to prove your income
• Employer contact information
• Your bank account number and routing number
• Proof of your monthly rent or mortgage payment

5. Apply

Once you’ve chosen the credit-builder lender you want to do business with and have your documents ready, you’ll fill out the lender’s full application. The process is typically all done online, and you can upload your financial paperwork through a secure portal on the lender’s website.

At this point, the lender will perform a hard credit pull and make a decision. If you’re approved, review the terms carefully and ask questions if you don’t understand how much you’ll pay each month, what the fees are or when you can access the loan funds.

6. Make payments and track your progress

Once you sign your final documents, you’ll begin making your monthly payments. Most credit-builder lenders set up automatic payments through your bank so you don’t miss a payment. Missing even one payment can significantly damage the credit you’re trying to build, so autopay is crucial.

After you make payments for a few months, start tracking your credit score progress. Ask your lender if it offers a free credit monitoring service and enroll in it so you can keep watch for movement in your scores. You could start seeing improvement in your credit score within 3 to 6 months of on-time payments.

4 Alternatives for building credit

A credit-builder loan isn’t the only way to improve or build your credit score. There are many other credit-building options to consider, depending on your needs and timeline.

• Secured credit card: If you’re looking for ways to build credit, a secured credit card can be a valuable option. These types of credit cards require that you establish a savings account with the credit card issuer and maintain a certain balance. These funds act as security for the line of credit. According to U.S. News, 27 percent of credit-invisible consumers have tried secured cards.
• Become an authorized user: If a parent, family member or spouse has a solid credit profile and a credit card account in good standing, ask if you can be added as an authorized user to the account. That individual’s credit history will then be added to your credit profile.
• Make bill payments on time: If you simply have a low credit score that you’re looking to improve, ensuring that you establish a consistent track record of paying all bills on time can help increase your score over time. Services like Experian Boost let you add utility, phone, and streaming payments to your credit file.
• Pay down existing debt: Yet another way to improve a low score is by focusing on paying down any existing debt you may have. Minimizing balances on credit cards and personal loans can go a long way toward improving a credit score. Credit experts generally recommend borrowing less than 30 percent of your available credit limits.

Best personal loan rates

Want to build your credit using personal loans rather than credit-builder loans? Check out the latest rates from the top personal loan lenders.

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Frequently asked question

• Should you use a personal loan to build credit?

  If you qualify, using a traditional personal loan to build credit could be an excellent alternative if you need funds right away and can comfortably afford the monthly payments.

  Before you do this, though, consider potential downsides like high borrowing costs and more debt. Traditional personal loans typically require credit scores of 580 or higher, making them inaccessible to credit-invisible consumers who would benefit more from credit-builder loans.