What Is a Credit Builder Loan?

If you want to learn how to build your credit, you have limited choices as banks, credit unions or online lenders might not be willing to give you a credit card or loan if you have no credit history. One alternative is a credit-building loan. With these, you can build or improve your credit history with on-time payments, making it more likely you will be eligible for credit cards or loans in the future.

So, what is a credit-builder loan? How do they work, and where can you get one?

What is a credit-builder loan?

The purpose of a credit-builder loan is to help you improve your credit through on-time payments to pay off the debt. A lender may extend a credit-builder loan because it wants you to be eligible for other products in the future like a car loan, mortgage or credit card.

[ More: What Credit Score Do I Need for a Personal Loan? ]

Usually, credit-builder loans are borrowed at low amounts, with easy repayment terms. And because they are credit builder loans, you most likely don’t need a credit history to apply for one. They’re generally used by young adults who have never taken on debt through credit cards or student loans.

How do credit-builder loans work? 

Credit-building loans work differently from traditional personal loans. With a regular loan, you apply with the bank, then receive your funds upfront to pay for expenses. From there, you pay off the loan in fixed monthly payments until you satisfy the debt.

However, with a credit-builder loan, you do not receive the money until you pay off the loan. How it works is you apply for a loan with the lender. Upon approval, it will tell you what your loan amount is — usually $300 to $1,000 — and how much interest you pay.

It will also include your repayment term that can range from six to 24 months, and your monthly payment. To illustrate, if you borrow $1,000 with an interest rate of 7% for a repayment term of one year, your monthly payments would be $87.

From there, the lender sets aside the money in a secured account until you pay off the debt. Once you pay off the debt, you receive the money.

It works for the lender because there is little risk involved since it does not provide you with the money until you pay off the loan. And it is beneficial for you because it gives you a way to build your credit.

Can a credit-builder loan really improve my credit score? 

Yes, a credit-building loan can improve your credit score. The lender that approves your loan reports your payment history to one or more of the credit bureaus. Considering your payment history makes up to 35% of your credit score, an account with a reliable payment history can go a long way to improving your credit score.

Conversely, if you do not make your payments on time, it can be detrimental to your credit score. It is why it is vital to set up automatic payments, so you do not forget and miss one.

[ See: Online or In-Person Loans: What’s Better? ]

Another tip is to refrain from paying off the loan early. Having a long history of on-time payments can raise your credit score more than only having a loan for a few months.

What is the minimum credit score to get approved for a credit-builder loan? 

When a lender considers you for a credit-building loan, it will look at several items like your credit score and income. In some instances, your job will play a much larger role, as the lender wants to ensure you can repay the loan.

Meanwhile, if you have a bad credit score, it might not disqualify you from using a credit-builder loan. One of the benefits on the lender’s end is you do not receive the money until you pay the loan off, eliminating the risk of loss.

Therefore, lenders are much more likely to be flexible if you have had credit problems in the past. The same goes for borrowers who are looking to establish their credit histories. It might be easier to obtain a credit-builder loan (provided you have reliable income) than an unsecured credit card.

How long will it take for my credit to improve?

If you make your payments on time, you could see a significant improvement in your credit score within six months. It is why a credit-building loan is such a wise option to consider when improving your credit because it requires you to establish a reliable payment history to receive the funds.

[ For You: The Common Types of Personal Loans, Explained ]

How to get a credit-builder loan 

To receive a loan, you will need to do the following:

1. Find a lender that offers these loans. Typically, your community banks might have a program, or you can go online to find a lender.
2. Next, you want to apply for a loan. You will need to supply your personal information like your name, address, phone number, Social Security number, income and more.
3. Provide any additional documentation your lender needs.
4. Once approved for the loan, read the loan’s terms. Doing so informs you of the amount you received approval for, the interest rate, and your monthly payment.
5. From here you want to set up automatic payments. Doing this allows you to pay your loan on time each month. Keep in mind the longer you pay off the loan, the more established your payment history is, so while the temptation might be there to pay it off early, refrain from doing so.
6. Once you pay off the loan, your lender will release the funds to you.
7. Check your credit history to see how a positive payment history impacts your credit score.

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