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Credit Builder Loans: What Are They and How Do They Work?

  • by Harita Solanki|
  • 0 Comment |
  • Updated: June 20, 2022 |
  • Loans

Key Features Of Credit Builder Loans

A good credit score typically means banks and lenders consider you less risky while offering you a loan. And though there are lenders who provide loans to people with bad credit, improving your credit score will only make you a more attractive borrower and open up more funding options for you.

There are various good ways to improve your credit score, and they can take their own sweet time to make an impact. You can choose a suitable option depending on your financial goal and how much you want to raise your credit score. If you wish to start building credit or rebuild your credit without a credit card, you can consider taking out a Credit Builder Loan. These loans are different from traditional ones but have proved beneficial in building credit, especially for people with no credit or poor credit.

If this loan type has grabbed your attention and you'd like to learn more, let's look at what credit builder loans are, how they help you build credit, and if they are suitable for you or not.

What Is A Credit Builder Loan?

Credit builder loans are called by various names, including fresh-start and starting-over loans. Regardless of what they're called, their purpose has always been to help borrowers build their credit.

A credit-builder loan is a specially designed loan with some of the advantages of installment loans that can help you make fixed repayments and create a positive credit history. The critical difference between an installment loan and a credit builder loan is the time of loan disbursement. Unlike any standard installment loan, you won't receive your loan amount upfront with a credit builder loan. The idea of credit builder loans is to help you build a history of regular payments, so you get access to the funds at the end of the loan's term only and only after you've paid fixed payments toward it over several months to a lender. Hence, you can use these loans as a way not just to build credit but also as a money-saving scheme.

Key Features Of Credit Builder Loans

Key Features Of Credit Builder Loans

How Do Credit Building Loans Work?

It must be evident that credit builder loans differ from many other loans. When you plan to take out a credit-building loan, your clear objective should be establishing a credit score or improving your current one. The chances are that there might be some savings that you probably didn't expect while improving your credit at the end of the loan term.

Now, if you're wondering how this happens, read on to understand the step-by-step process of using these loans to build credit:

How do credit building loans: work step 01
Your first step will be to identify a suitable credit builder loan lender for you. Selecting the right online lending company won't be challenging as it's much easier to identify the possible lenders and compare their loan terms online. Once you've found the right lender, apply for a credit-builder loan and get approved.
How do credit building loans: work step 02
When you decide the loan amount, generally in increments of $300 to $1000 as per the Consumer Financial Protection Bureau, your lender will create a savings account or a certificate of deposit where your funds will be deposited. You won't have access to the money until you pay the loan in full by the end of a specified date.
How do credit building loans: work step 03
The usual loan term of a credit builder loan is over six to twenty-four months. You'll have to make regular monthly payments with a portion of your principal amount and interest until the loan is completely paid off during this term. This makes repaying a credit building loan more manageable and convenient.
How do credit building loans: work step 04
Each monthly repayment you make will be reported to all three major credit bureaus: Experian, TransUnion, and Equifax. The information of every payment you make will show up on your credit report. Since your payment history affects your credit score largely, you'll be able to see your credit improve by merely building a solid payment history.
How do credit building loans: work step 05
Your lender will release your borrowed funds soon after you've paid off your credit-builder loan in full at the end of your loan term. The funds might get directly deposited in your account by the lender, and you'll be free to use them however you want. Any additional savings you see by taking out a credit-builder loan is a bonus!

It's essential to note that these steps may vary from lender to lender and state to state. Check the detailed credit building loan procedure with the chosen lender before signing the loan agreement.

What Are Their Pros And Cons?

A loan that works for someone else may not be the right solution for you. So, here are a few essential pros and cons of credit-building loans that you can consider before you decide to use them for building credit from scratch or improving low credit scores:

Pros

  1. Every on-time payment on your credit builder loan is reported to the major credit bureaus to assist you in building credit over the loan term.
  2. Most credit builder loan lenders consider only your income for approval, making the loans easier to qualify whether you have bad credit or no credit.
  3. These loans work as a great tool to save money as you land up with a lump sum of money in your bank account at the end of your selected term.

Cons

  1. Making repayments for a credit builder loan may feel like a burden when you need cash immediately and would require taking out a quick personal loan instead.
  2. The interest and fees that the lender charges may not always be refundable, making the loan costlier for you.
  3. If you have poor credit, missing payments on a credit builder loan could further reduce your credit score.

How Much Does A Credit Builder Loan Cost?

The cost of your loan can be determined by various factors like annual percentage rate (APR), application or origination fees, late fees, etc. Your lender decides the interest rate and origination fee you will be charged according to the governing law and jurisdiction. You can avoid any late fees by not missing your repayment due dates.

Since you get the principal loan amount once you've finished making all the fixed payments over several months, anything you pay over the principal and is not refundable becomes the actual borrowing cost of a credit builder loan. If you're fortunate and your lender deposits your loan balance in an interest-earning account, you might be able to reduce your overall cost of the loan.

How Can I Get A Credit-Builder Loan?

Suppose you have no credit history, poor credit, or want to improve your credit score. In that case, you can find a credit builder loan at small financial institutions, such as local credit unions, community banks, and a few online lenders. Credit builder loan requirements are more or less similar to most bad credit loans. You don't need a good credit score to qualify for a credit-building loan, as they are fundamentally designed for people who intend to build and rebuild their credit. This could mean that no credit checks are required to get these loans. With that in mind, you'll need to meet some essential loan eligibility criteria to qualify for a credit builder loan.

Common Requirements Of Credit Builder Loans

18 Years of Age or Older

18 Years of Age or Older

Employment information

Employment information

Social Security number

Social Security number

Proof of income

Proof of income such as Pay stubs, tax returns

Balances in checking and savings account

Balances in checking and savings account

References

References

Is A Credit Builder Loan A Good Idea?

A credit builder loan is a unique financial tool that might work if you can keep up with the regular payments. Your payment history makes up 35% of your credit score; therefore, these loans target improving a solid payment history to build good credit. If you can make on-time payments, a credit building loan might be the perfect option. Conversely, you might see no improvement or end up hurting your credit even more if several late or missed payments are reported to credit bureaus.

If you don't find a credit builder loan a good fit, you can explore alternative credit options that could help you build a credit history. Credit building options include secured credit cards and unsecured and secured personal loans. Yes, secured credit cards are available, which require you to deposit a refundable amount almost of the value of your credit limit. Like a credit builder loan, you may see your credit improve if you make on-time payments. Some lenders will let you switch your secured card to a non-secured card after a certain amount of on-time payments, which means you'll get your deposit back.

Secured and unsecured personal loans can help you get funds instantly and build a good payment history at the same time. With flexible repayment terms, you might not even feel the burden of paying back the loan on time. And while some lenders don't check your credit score when you apply for installment loans to build credit, you need not worry about hurting your credit while borrowing a loan.

Ultimately, before choosing a credit builder loan or one of its alternatives, it's wise to analyze your financial situation and do in-depth research about all the options.

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