What is a credit-builder loan?

Whether you’re building first-time credit or rebuilding your credit, you could consider a credit-builder loan. A credit-builder loan is different from a traditional loan. With a traditional loan, you might receive the money you’re borrowing upfront and pay it back over time. But with a credit-builder loan, you make fixed payments to a lender and then get access to the loan amount at the end of the loan’s term.

Read on to learn more about how credit-builder loans work and how they could help you build credit.

Key takeaways

• A credit-builder loan gives you an opportunity to show that you can handle consistently making on-time payments. And since your payment history is such an important factor in calculating your credit scores, it could help you build credit.
• Credit-builder loans may be offered by community banks, local credit unions, online lenders and financial technology companies.
• Good credit scores aren’t required in order to open a credit-builder loan. But you may have to pay a fee upfront.

If your credit-builder loan application is approved, you can then expect the following:

• Your lender sets aside the money: Your lender will set up a savings account or a certificate of deposit (CD) with the loan amount—usually $300 to $1,000, according to the Consumer Financial Protection Bureau (CFPB). Depending on the account and the lender, the loan might earn interest.
• You make monthly payments: You’ll make payments toward the loan—with interest—in installments, usually over the course of six to 24 months.
• Your lender should report your payments to the credit bureaus: Your lender should report the details of your payments—including whether they’re on time—to at least one of the three major credit bureaus every month.
• You get access to the money: If you’ve made all your payments on time by the end of the loan’s term, your lender will make the funds available to you.

When you’re building credit from scratch or rebuilding your credit, a credit-builder loan gives you an opportunity to show that you can handle consistently making on-time payments. And that can help you build credit since your payment history is such an important factor in calculating your credit scores.

Keep in mind that your credit-builder loan won’t help you build credit if you miss payments or pay late. If you make a late payment or miss a payment altogether, your lender will likely report it to the credit bureaus. And that could hurt your credit scores.

You can find credit-builder loans at community banks and local credit unions. There are also online lenders and financial technology companies that specialize in helping people build and rebuild their credit. Credit-builder loans may be one of the products offered by these types of lenders.

Credit-builder loan requirements

You don’t need to have a good credit score to qualify for a credit-builder loan—they’re designed for people building and rebuilding their credit, after all. And some credit-builder loans don’t require credit checks. However, some lenders may take a look at your banking history through a consumer reporting agency—like ChexSystems for example. And when you apply, you’ll likely be asked to provide things like employment information and proof of income. You may be asked to provide other information too—such as loan balances and checking and savings account balances.

It’s also worth keeping in mind that you may have to pay a fee upfront when opening your loan account. 

Whether a credit-builder loan is a good idea depends on the borrower’s own unique financial situation. As the CFPB explains, credit-builder loans may be “especially beneficial” to those “without a credit score or those with no existing debt.”

And the CFPB goes on to say that “consumers who do have debt may want to consider paying down other loans before opening a [credit-builder loan] or choosing other products and services to help them build credit.”

A credit-builder loan is just one option for building credit. Whether you have poor credit or no credit history, here are some other ways you might be able to help build or rebuild your credit:

A secured credit card

With a secured credit card, you get access to a line of credit upfront that you can use to make purchases—just like you do with an unsecured credit card. But unlike an unsecured card, a secured card requires you to pay a security deposit in order to open the account. 

Keep in mind that the security deposit is often refundable. And many secured cards don’t come with any annual fees. The Platinum Secured card from Capital One, for example, has no annual fee and can be opened with a security deposit of $49, $99 or $200. And you can earn back your deposit as a statement credit if you use your credit card responsibly. Otherwise, it will be refunded when you close your account and pay your balance in full.

Some credit card companies—including Capital One—report secured credit card use to the credit bureaus. So if you’re using your card responsibly and paying at least your minimum payment on time, using a secured card could help you improve your credit.

But keep in mind that missed or late payments could hurt your credit. And so could exceeding your credit limit.

Become an authorized user

A loved one or someone you trust could add you as an authorized user to their credit card account. This allows you to make purchases, but the primary cardholder is the only one who is ultimately responsible for payments. And their responsible use can help you build your credit and improve your credit scores. Plus, there’s generally no credit check or need to apply in order to become an authorized user. 

Just be sure to check with the card issuer to see how it handles reporting authorized users to the credit bureaus. You won’t be able to build credit as an authorized user if the issuer doesn’t report authorized user activity.

Some issuers, like Capital One, may also provide features such as online access to eligible authorized users. On its own, it won’t help you build credit. But it could let you practice responsible credit habits, such as making payments on time, reviewing card activity and more.

A personal loan

Depending on the lender, you may be able to qualify for a personal loan even if you have no credit or poor credit.

But keep in mind that if you’re building or rebuilding your credit, your options may be limited. For example, you may only qualify for a secured loan, which requires collateral. And if you default on your loan payments, you could lose your collateral to the lender. And some personal loans, like payday loans, come with their own unique risks and are unlikely to help you build credit.

A credit-builder loan can be a great tool for helping you build or rebuild your credit. But there are other credit-building options out there too.

No matter which option you consider, be sure to do your research so you can make an informed decision on the best credit-building option for you.