Key takeaways:
- Credit builder loans can be a useful tool to start your credit history.
- Your payment history will be reported to one or more of the credit reporting agencies.
- Credit builder loans can have fees and a fixed interest rate.
- Instead of getting money immediately, your payments go into a dedicated savings account.
- When the loan term ends, you’ll gain access to the savings account.
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Loans to build credit
A credit builder loan is an installment loan used for the purpose of helping people establish a credit history or rebuild their credit. For most other personal loans, you would receive money for a specific purchase or financial goal, like debt consolidation, home improvements and other large purchases. Credit builder loans work differently.
How does a credit builder loan work?
When you take out a credit builder loan, you don’t receive the money directly from the lender. Instead, the lender will put your monthly payments, which are a mix of principal and interest, into a savings account. As you continue to make your monthly payments, the amount in that savings account grows until you’ve made all the payments according to the term of your loan. When you’ve made all your payments, you will then have access to the savings account.
Typically, any interest or fees charged by your lender are not added to your savings account. Essentially, the interest and fees, if there are any, is the cost for building credit and your forced savings. This can make it costlier than other ways to build credit, like a secured credit card or becoming an authorized user.
Where to get a credit builder loan
If you are already using a bank or credit union, you can ask if they offer credit builder loans to customers. But it’s always best to shop around for the best rates and terms for you. In addition to brick-and-mortar banks, there are several online banks that offer credit builder loans. Compare interest rates, terms and any potential fees from multiple reputable institutions before applying.
Terms for credit builder loans will vary by lender, but many last between 12 and 24 months. The loan amount will depend on the lender you choose, but you can expect to be able to fund between $500 and $3,000, depending on the length of your loan. Some lenders may offer loan terms and funding amounts outside of those parameters. Your particular loan amount and term will depend on your personal financial status and the lender you choose.
Pro Tips:
- Shop around for a loan that works best for you
- Be mindful of interest rates and fees
- Set up automatic payments if possible
How credit builder loans impact your credit
Lenders will report your loan activity to one or multiple credit reporting agencies, which can help you build a healthy credit history. You can ask your lender where they report your account information. You can also get a free copy of your credit reports from TransUnion, Equifax and Experian each week at annualcreditreport.com. Regularly review your credit reports to be sure they are an accurate reflection of your credit history. If your credit builder account is reported to TransUnion and remains in good standing, you will see it in the Satisfactory Accounts section of your credit report.
Making on-time payments on your credit builder loan account is crucial because your payment history is one of the most important credit score factors. If your credit builder loan account history shows consistent on-time payments, it can have a positive impact on your credit score.
Alternatively, if you miss payments or default on your credit builder loan, it could negatively impact your credit health. If you default, the lender may demand payment of the remainder of your loan amount and may take the funds you owe out of the savings account you’ve been slowly building.
Also know that when you apply for your loan, lenders analyze your credit history which may require a hard inquiry which can impact your credit score. Hard inquiries tend to be one of the least impactful credit score factors and their impact on your score tends to lessen over time.
Other ways to build credit
Credit builder loans are just one way to build credit. You can also consider a secured credit card. A secured card acts like a normal credit card, but it requires a deposit and that deposit acts as the card’s credit limit. Some banks also offer standard credit cards specifically for bank customers to help them establish a credit history. The bank may have specific requirements, like a certain minimum balance across bank accounts to be eligible. Lenders that offer these types of cards will report the account information to credit reporting agencies.
Another way to get a jumpstart on building credit is by becoming an authorized user on a credit card account of someone you trust, like a family member. The primary account holder will need to add you as an authorized user on the account and ultimately, they are responsible for all the activity on the account. As an authorized user, you can build credit history because you will inherit the history of the credit card account. This is a financial relationship that is based on trust. You will inherit both positive and negative history, so if the primary account holder is not properly managing the account and missing payments, that could reflect in your credit history as well.
Building your credit is a worthwhile goal. Whatever option you choose to get started, whether a credit builder loan, secured credit card or another alternative, know that building credit doesn’t happen overnight. But if you're mindful of your finances, create a budget and practice healthy credit habits, you can reach your credit goals.
