The Benefits of Credit Builder Loans

Jason SteeleUpdated August 23, 2023

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If you have bad credit or no credit history at all, you may be looking at how to build your credit score. A credit builder loan can help you build your credit score by adding a positive credit history. Keep reading to know how credit builder loans work, how to apply for one, and how a credit builder loan can help build your credit over time.

What Is a Credit Builder Loan?

A credit builder loan is a type of secured loan. It works similarly to an installment loan, except in reverse. With credit building loans, you won’t get the money until you actually finish making all of the loan payments. Since credit builder loans are often used by people who have bad credit or no credit history at all, it is less risky for the lender to withhold the loan money until they have received all the payments.

How Do Credit Builder Loans Work?

After you apply for the credit builder loan, you will find out about your approval. If you are approved for the credit builder loan, the loan amount that you are borrowing is set aside in a secured savings account or certificate of deposit (CD) for the duration of the loan term. You will make fixed monthly payments to the lender. Like any loan, the lender will report your payments to the three credit bureaus — Experian, TransUnion, and Equifax. This will help build your credit, as long as you make your payments on time and in full every month. After you have made all of your payments, you will receive the money at the end of the loan’s term. You can deposit the money from the secured savings account or certificate of deposit into your bank account. You will then be free to use the money however you want. The final amount that you receive will be for the full amount that you borrowed, minus any fees or interest that was charged.

Credit Builder Loan Interest and Fees

Some examples of fees that could be charged for a credit builder loan include administrative fees and late fees. Administrative fees are usually paid upfront and can range from $9 to $15. Late fees will be charged if you miss a payment on your credit builder loan. Late payment fees may be a percentage of the monthly payment added to your normal payment amount.Your loan may also charge interest. The interest rate is the interest charged on the loan each year, while the Annual Percentage Rate (APR) is the interest as well as other fees. Interest rates and APRs for loans can range from single to double digits. Recommended: APR vs Interest Rate on Personal Loans

The Benefits of Credit Builder Loans

Credit builder loans can be especially helpful to people who have poor credit or no credit history. They allow borrowers to establish credit as the borrower responsibly pays back the credit builder loan before it’s dispersed. Benefits of credit builder loans include:

Easier to qualify and get approved for as opposed to a traditional loan
Helps build credit if payments are made on time
Increases chances of getting approved for loans in the future

If you have poor credit or no credit history, it can be especially difficult to get approved for financial products and services, like credit cards or personal loans. Credit builder loans allow borrowers to build their credit scores by making consistent, on-time payments, which then helps them qualify for other loans down the road.

How Can Credit Builder Loans Help Build Your Credit Score?

If you can’t qualify for a traditional loan due to poor credit or other factors, credit builder loans can be an option. When you make payments on time, it can positively affect your credit score through your payment history. Making payments on time can also help build healthy money habits, which can carry over into other parts of your financial life. On the flip side, missing a payment on your credit builder loan can have a negative effect on your credit score. If you have other existing debt, it may be difficult to make the monthly payments. To prevent this, make a realistic monthly budget to ensure that you have enough money set aside to pay the credit builder loan payments in full.Recommended: What Is Budgeting and How Can You Start?

How Much Can You Borrow with a Credit Builder Loan?

Credit builder loans are usually for small amounts, typically between $300 and $1,000. The APR and fees on the credit builder loan will vary.

How Long Does It Take to Build Credit with a Credit Builder Loan?

Terms for credit builder loans are usually between six and 24 months. This is good for those who are looking to establish credit because you need at least one credit account open and reporting to at least one of the major credit bureaus for at least six months to generate a FICO® credit score. You can, however, get a VantageScore® as soon as your first account gets reported to the credit reporting agencies. Recommended: What Is a Good Credit Score?

How Do You Qualify for a Credit Builder Loan?

Since credit builder loans are for people who are looking to build their credit, they usually have low credit score requirements. Some credit builder loans don’t even require a credit check. Keep in mind that you may still need to provide information like proof of income, proof of employment, and your checking and savings account balances prior to approval.

The Takeaway

Only you can decide if a credit builder loan is the right fit for you. If you have a low credit score or no credit history and also little to no existing debt, you may be a good candidate for a credit builder loan. If you decide that a credit builder loan is not the right choice for you, some other options to explore include applying for a secured credit card, becoming an authorized user on a family member’s credit card, or applying for a personal loan. If you are looking to apply for a personal loan, Lantern can help. Lantern lets you compare the top personal loans to find the one that is right for you.Lantern can help you compare rates and find loan offers in minutes.

Frequently Asked Questions

How does a credit builder loan work?

How much can you get with a credit builder loan?

Are credit builder loans worth it?

How much do credit builder loans cost?

How long should I have a loan to build credit?

Photo credit: iStock/humanmade

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About the Author

Jason Steele

Jason Steele has been writing about credit cards and award travel since 2008. One of the nation's leading experts in this field, he has contributed to dozens of personal finance and travel outlets and has been widely quoted in the mainstream media.

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