What Is a Credit Builder Loan?

If your credit isn’t great, but you want to make it better, you might be at your wits’ end. Fortunately, there’s a lesser-known credit product known as the credit builder loan.

You won’t find a credit builder loan down at your local megabank. Instead, these are products offered by small community banks and credit unions for people like you — those with less-than-perfect credit — to build their credit up to something more respectable.

So what is a credit builder loan? Who are they right for? And perhaps most importantly, how do you get one?

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    What Is a Credit Builder Loan?

    Like the name implies, a credit builder loan is a loan that exists to help you improve your credit. Why would a community lender or credit union want to do this? Simply because when you have better credit, you’re more apt and able to consume other big-ticket products they sell, like car loans and mortgages.

    It’s not entirely mercenary on their part — you’d probably like to get a car loan or a mortgage one day, too. So aren’t you glad that products like credit builder loans (also known as “starting over loans” and “fresh start loans”) are there to help you get your credit back on track?

    How Do Credit Builder Loans Work?

    Don’t spend the money quite yet. The bank is able to offer these loans because they’re extremely low-risk to them. The money is deposited into a bank account that you can’t access until the loan is paid off. So you get the loan, make payments over the agreed-upon term, and when the loan is all paid off you get basically all of the money back.

    In exchange, the credit union or community lender will report to the credit bureau that you repaid a loan according to the terms. That’s going to help you to build credit, especially if you’re new to the credit game.

    And, as usual, if you fail to make payments, you’re going to see your credit score decline even more. So if you get one, make sure to make all of your payments on time.

    Who Is a Credit Builder Loan Right For?

    There’s a very specific customer in mind for the credit builder loan: people who would normally otherwise get a secured credit card, but can’t afford to put up the security deposit or otherwise don’t qualify.

    This is effectively a loan for people who are slipping between the cracks. If you already have available credit and are still qualifying for other products, a credit-builder loan probably isn’t for you. On the other hand, if you’ve damaged your credit and want to improve it, or simply have no credit history to speak of, a credit builder loan might be what you’re looking for.

    However, you can also get a credit builder loan if you have average credit and some cash on hand, and just want a boost to your credit. (Making the jump from fair credit to good or excellent credit can save you buckets of money in a lifetime.) In this case, you’d take a bit of money you have saved up, deposit it from an account you already have, and let the bank hold onto it. You make monthly payments on that money through the credit builder loan, and get a positive mark on your credit score for your trouble.

    If you need cash right away, a credit builder loan isn’t the right option for you. What’s more, if you have poor credit and you want an unsecured loan to get some cash in your pocket, be prepared to pay through the nose. Sometimes the interest rates on those loans are in the mid-30s – making them that much harder to pay off. If you don’t really need the cash, it’s best to opt for some other way to improve your credit score.

    How Do You Get a Credit Builder Loan?

    Go down to your local community bank or credit union, and ask them if they offer this product and if it’s right for you. If it’s not, they’ll likely steer you toward a credit product that’s more in line with your needs and situation. That’s one of the great things about credit unions and community banks — they’re always willing to find the right solution for you.

    Nicholas Pell

    Contributing Writer

    Nicholas Pell is a freelance personal finance writer specializing in student loans, consumer credit and living a champagne life on a Kool-Aid budget. In addition to The Simple Dollar, he’s written for Business Insider, Fox Business, WiseBread and MainStreet.