What is a credit-builder loan?

A credit-builder loan is a small installment loan designed to help people who are building credit show a positive payment history. Instead of receiving the money up front, borrowers make fixed payments and then get access to the loan amount at the end of the loan term. That’s different from typical loans, which involve borrowing money up front and then repaying it over time.

What you’ll learn:

• A credit-builder loan allows you to show that you can make consistent, on-time payments. 

• Credit-builder loans could be beneficial if you have little to no credit history or you’re looking to improve your credit scores.

• Banks, credit unions, online lenders and financial technology companies may offer credit-builder loans.

• There may be fees to open a credit-builder loan.

With a credit-builder loan—sometimes referred to as a credit-builder account—a lender opens a certificate of deposit (CD) or savings account in your name. Then you make monthly payments, plus interest, until the loan is paid off. After repaying the loan, the lender gives you access to the funds. The way you build credit is by the lender reporting those on-time monthly payments to the three major credit bureaus. 

For example, you take out a $500 credit-builder loan with a 9% interest rate and a 12-month repayment term. Your estimated monthly payment is about $44. After making all monthly payments on time, you should have access to the $500 minus any fees.

Getting approved for a traditional loan or credit card can be a hurdle if you don’t have a strong credit history. A credit-builder loan can bridge that gap. It can benefit someone who is:

• New to credit: People who are just starting their credit journey, haven’t used their credit in a long time or have just immigrated to the U.S. and are looking to establish their credit history may benefit from a credit-builder loan.

• Considered credit invisible: Credit-builder loans could be useful to people who have thin credit files, sometimes referred to as credit invisible, because they have very little credit history.

• Rebuilding credit: This may include those who haven’t used credit in years or are trying to repair a poor credit score.

A credit-builder loan can help build credit because it allows borrowers to establish a positive payment history. 

In most cases, lenders report payments made on the loan to the credit bureaus. So whether you’re building credit from scratch or rebuilding your credit, a credit-builder loan allows you to demonstrate that you can handle making consistent, on-time payments, which can help you create a positive payment history.

Consistency is key—missing a payment can set your progress back, so it’s smart to set up auto-pay if your lender offers it.

Here are some general steps to getting a credit-builder loan.

You may be able to get credit-builder loans from:

• Community banks

• Local credit unions

• Online lenders

• Financial technology companies that specialize in helping people build or rebuild their credit

Credit-builder loans may not be advertised, so you might need to inquire directly with banks or credit unions to find them.

When choosing a loan amount, understand what the monthly payments will be to ensure you’re not maxing out your budget. Credit-builder loans can range from $300 to $1,000 and are typically over a term of six to 24 months, according to the Consumer Financial Protection Bureau (CFPB). 

Interest charged on the loan adds to the monthly payment, but certain loan providers might return some of the interest paid in the form of dividends at the end of the term.

Lenders might look at your banking history through a consumer reporting agency like ChexSystems. A credit-builder loan won’t typically require a credit check, so that can make it easier to qualify for than other types of loans.

When you apply, you could be asked to provide information like:

• Employment details 

• Proof of income, like pay stubs or tax returns

• Loan balances

• Photo ID

• Housing, loan and credit card payment information

• Checking and savings account balances

Once you know what the monthly payment will be, review the terms and fees associated with the loan. The loans are designed to help people build credit, but it could be worth confirming which bureaus the lender will report to. Without the reporting, there’s no way to build credit. And in addition to an up-front fee, you may need to pay an application fee and a processing fee.

After providing any necessary information and reviewing the terms and fees, you can submit the application. The lender might request more details before you’re approved. While some lenders accept every applicant, others could have certain qualifying guidelines that must be met.

Once your application is approved, the lender will place the loan amount in an account. You’ll start making fixed monthly payments for a set term. You’ll begin building your credit history as you make timely payments that the lender reports to one or more of the major credit bureaus.

Credit-builder loans can be a helpful option if you’re credit invisible or want to raise your credit scores. If you have the income to make regular on-time payments, a credit-builder loan may be an option worth exploring.

But be aware of interest rates and fees, which can add costs to your loan.

Benefits of credit-builder loans include:

• Ease of qualification: If you have poor credit or no credit history, credit-builder loans may be relatively easy to qualify for compared with other types of loans and credit. 

• Ability to improve credit scores: Credit-builder loans can help you build a positive credit history if you make at least the minimum payment on time each month and the lender reports to the credit bureaus.

Potential downsides of credit-builder loans include:

• High interest rates and fees: Credit-builder loans may come with higher interest rates and fees than other loan types.

• No up-front access to funds: Unlike with other types of loans, you don’t get access to the loan funds until all payments have been made at the end of the loan’s term.

• Possible damage to your credit: Even though credit-builder loans are meant to help build credit, they can negatively impact your credit history and credit scores if payments are late or missed.

Alternatives to a credit-builder loan include secured credit cards, becoming an authorized user on someone else’s credit card account and reporting rental payments. 

Whether you have poor credit or no credit history, here are some other ways you might be able to build or rebuild your credit instead of using a credit-builder loan:

If you want access to a line of credit to use for daily purchases while building your credit history, a secured credit card might fit your goals better than a credit-builder loan, but only if you use it responsibly by doing things like paying statements on time every month. Secured cards are typically easier to be approved for than traditional credit cards because they require a refundable security deposit to open the account. 

For example, the Capital One Platinum Secured card has no annual fee and can be opened with a security deposit of $49, $99 or $200. View important rates and disclosures.

Another option is to consider becoming an authorized user on the credit card account of someone you trust. First, verify whether a card issuer reports authorized users to the credit bureaus.

Once you’re an authorized user, the card’s account history may be added to your credit reports, although the primary cardholder is responsible for making payments. If you and the primary cardholder use the card responsibly, it could help you build credit. But irresponsible use could hurt the credit scores of both the account holder and you.

You may be able to report monthly rental payments to credit bureaus. While credit reports don’t usually contain rental payments, you can speak with your landlord or sign up for a third-party service that reports them.

A credit-builder loan offers one way to build credit. But there are other credit-building options out there, too, including credit cards from Capital One designed for building credit. You can compare options and see if you’ll be approved—without hurting your credit scores.