What’s a Credit-Builder Loan? (And Why To Get One)

Having zero credit history or bad credit can make getting approved for a loan difficult, whether it’s a personal loan, mortgage, or auto loan. Making regular, on-time debt payments can improve your score, but if you don’t have and aren’t eligible for a loan or credit card to make payments on, it can be hard to make progress.

This is where a credit-builder loan can come in handy. These are designed to help borrowers with no credit or bad credit improve their credit history and score, though the funding process looks very different compared to a traditional loan.

What is a credit-builder loan?

A credit-builder loan is an unconventional type of loan offered by some lenders to help you build up your credit and possibly save. They’re relatively small loans, and the loan amount doesn’t go directly to you when you take out the loan. 

Instead, it’s put into a locked account that you can’t access until you’ve made all of your monthly payments. In other words, you get the loan amount at the end of repayment, not the beginning.

Like other loan types, credit builder loans have an annual percentage rate (APR). The APR accounts for the loan’s interest rate plus any upfront fees, and indicates how much the loan costs. A lower APR means a lower cost of borrowing, and vice versa.

Related: What Is a Personal Loan Origination Fee?

The payments you make are reported to at least one (but ideally all three) of the major credit bureaus — Experian, Equifax, and TransUnion. If you make all your payments on time, this can help you establish a positive credit history and possibly raise your score.

How does a credit-builder loan work?

With a credit-builder loan, the lender puts your loan amount into a savings account or certificate of deposit (CD). To access the funds, you repay the loan in full over a series of monthly payments.

Credit-builder loan amounts are modest — $500 to $3,000, depending on the lender — and repayment terms are usually short, between six and 24 months.

Check Out: Types of $500 Loans

Annual percentage rates (APRs) may range from around 5% to 16% or more, depending on the lender. Since this type of loan is geared toward those with limited or poor credit, lenders typically don’t have minimum credit score requirements for credit-builder loans and may not require a credit check.

How to get a credit-builder loan

You can get a credit-builder loan with an online lender, credit union, or bank that offers this type of lending product. It’s worth noting that not all financial institutions offer credit-builder loans. 

For instance, many large banks do not offer credit-builder loans. When looking for credit-builder loans, make sure you’re working with a reputable lender. Check the Better Business Bureau and customer review sites like Trustpilot.

Read More: 8 Signs of Personal Loan Scams

To get a credit build loan, follow these steps.

1. Compare options: Look at multiple options from different lenders and review the repayment terms, APRs, and fees side-by-side. You may be able to see if you prequalify with some lenders. Once you’ve done your research and compared rates and fees, you can choose the best option for your needs and budget.
2. Apply for a credit-builder loan: Provide your personal information, like name and date of birth, plus employment and income information, then submit your application online with your preferred lender. Unlike traditional loans, some credit-builder loan lenders don’t require a credit check or conduct a hard pull when you apply. If there is a hard inquiry, your credit score may be impacted and temporarily lead to a slightly lower score.
3. Make on-time payments: After being approved for a credit-builder loan, your lender will deposit your loan amount into a locked savings vehicle. To build credit, you’ll pay off that amount for the specified term. This establishes a positive repayment history with the credit bureaus.
4. Get your money: Once the repayment term is up, you can access the loan amount.

Should I get a credit-builder loan?

If you have yet to establish a credit score and have tried other alternatives, a credit-builder loan may be a good option. A credit-builder loan is one way to add an installment loan to your credit history. On-time payments can build your credit over six months or so.

Before moving forward, make sure you can easily fit the monthly payments in your budget and review potential interest rates and fees.

Using a personal loan to build credit

Personal loans can be an alternative to credit-builder loans. Some lenders offer personal loans to borrowers who have no credit history or have bad credit.

Getting a personal loan from one of these lenders means you get the loan amount upfront, which is then repaid in fixed monthly installments.

Additionally, you might consider a secured personal loan or adding a cosigner if approval is difficult. 

Secured loans

Secured personal loans require that you put down collateral (something that has value), which the lender can seize if you default on the loan.

By having something to back the loan, the lenders reduce their risk of lending to you. Often, the APR on secured personal loans is less than on unsecured loans because of the collateral, but not all lenders offer them.

Compare: Secured vs. Unsecured Personal Loans

Loans with a cosigner

Cosigners can help with approval, but there are some important points to consider. First, the cosigner should have excellent credit and a good income to help you qualify for the loan. 

(A cosigner is often a spouse, close family member, or close friend.) Secondly, the cosigner is also held responsible for the loan. In other words, if you don’t make the required payments, it can affect your cosigner’s credit and they’ll be responsible for payments toward the loan.

Note that not all lenders offer personal loans with cosigners.

Check Out: Best Personal Loans With a Cosigner

Other ways to build credit

Credit-builder loans can be a useful tool for consumers with no credit score or history. They may also help if you have bad credit and want to show that you’re a responsible borrower. But there are other ways to build credit that can be used along with or instead of a credit-builder loan.

• Become an authorized user: One way to easily build credit is to become an authorized user on someone else’s credit card. As an authorized user, you’ll get access to their credit line, but the primary cardholder is responsible for payments. This can be a great way to establish a credit history. Just make sure to discuss spending with the primary cardholder and also ensure they make payments on time so you can reap the benefits.
• Get a secured credit card: If you have no credit history or have poor credit, lenders may be wary of approving you as a borrower. A secured credit card helps solve that problem. You provide funds of $50 to $300, depending on the card, which is your upfront deposit. That amount typically serves as your credit limit. You can use the card from there and rebuild credit through timely monthly payments.
• Get a retail credit card: If you have a favorite retail store or gas station, you may qualify for a retail credit card. Typically, these cards don’t have strict eligibility requirements but, as a result, may have higher rates. Unfortunately, they typically come with low credit limits as well.
• Keep credit card balances low: This is important to note, as credit utilization is an important factor affecting your credit score. It’s best to keep your overall balance below 30% of your limit. If you do that and make on-time payments, you will likely improve your credit score.
• Make payments on time: If you have any loans or credit cards, it’s crucial to make on-time payments. This is the single most important factor in your FICO score (it contributes 35%). Timely payments will give the biggest boost to your score over time, while a history of late and missed payments will hurt it.

Related Articles:

• How Do Personal Loans Work?
• Does Applying for a Loan Hurt Your Credit Score?
• Does Paying Off a Loan Help Your Credit Score?
• How Personal Loans Affect Your Credit Score?
• What To Do If You're Denied a Personal Loan
• Best Personal Loans

Disclosure: Some lending partners that participate in Credible’s comparison marketplace offer loans to borrowers with scores as low as 550. Borrowers with low scores will have fewer lending options than borrowers with higher credit scores.