What Is a Credit Builder Loan and How Does It Work?

Do you want to improve your credit score but don’t know where to start? A credit builder loan might be the perfect solution for you. Trying to build credit can be challenging, especially if you don’t qualify for an unsecured credit card yet.

A credit builder loan allows you to build credit by making payments on time on a short-term loan. Some loans even work as savings accounts allowing you to get all your payments returned to you at the end of the loan repayment term. Let’s discuss how credit builder loans work, along with some pros and cons to consider.

What Is a Credit Builder Loan?

A credit builder loan is a type of loan designed to help people build or improve their credit score. The loan works by having the borrower make regular payments that are reported to the credit bureaus. This means that you can build up a positive credit history while paying off the loan.

Credit builder loans are generally offered by community banks, credit unions, and online lenders. The loan amount is usually small, and the interest rates are relatively low. Some credit builder loans may require you to make a deposit that is held in an account as collateral.

How Can a Credit Builder Loan Help You Build Credit?

By making payments on time, a credit builder loan can help you establish a positive credit history. This is particularly important if you have no credit history or have a poor credit score. A good credit score is essential if you want to obtain a mortgage, car loan, or credit card with favorable rates and terms.

Credit builder loans also help you develop good financial habits. When you take out a loan, you are responsible for making regular payments. This can help you develop a habit of budgeting and planning your finances. You may also become more cautious about taking on new debt because you don’t want to damage your credit score.

How to Get a Credit Builder Loan

To get a credit builder loan, you’ll need to find a lender that offers them and apply. The lender may need to see proof of income, and some may require a deposit that is held in an account as collateral.

Typically, credit builder loans have a short repayment term, anywhere from six months to two years. You’ll need to make regular payments on time to establish a good payment history.

It’s best to start by asking your bank or credit union if they offer credit builder loan and what the terms are like. Or, you can consider an independent lender or loan company like Self. Self specializes in low-cost credit builder loans with repayment terms of 24 months.

With Self, you pay an admin fee and interest fee but get to receive the bulk of your payment back at the end of the 24-month term.

Pros and Cons of Credit Builder Loans

It’s important to carefully consider the benefits and drawbacks of a builder loan before you determine if this option is right for you.

Pros:

  • Credit loans can help you build a positive credit history. Payment history is one of the biggest factors that impacts your credit score and a credit builder loan helps you build positive payment history so long as you’re making payments on time.
  • They can help you develop good financial habits like budgeting and saving. With a credit builder loan, you’ll make regular monthly payments and receive the total amount you contributed at the end of the repayment term. This helps you build a habit of setting a fixed portion of money aside and budgeting for savings.
  • The loan amounts are usually small, and the interest rates are relatively low. While credit builder loans do have fees, loan amounts are usually small which can keep fees on the lower end.

Cons:

  • The deposit required for some loans can be a burden on your budget. Some credit builder loans require an upfront deposit, so you’ll want to budget in advance for this.
  • You may have to pay a small fee to set up the loan. Loans may also have fees so be sure to shop around and compare loan terms to make sure you’re getting the best deal.
  • If you miss a payment, it can damage your credit score. Budget for monthly payments and consider setting up automatic payments so you never miss a payment.

Summary

Building credit takes time and effort, but it’s worth it. A credit builder loan can be a useful tool to help you build or improve your credit score. Remember to research lenders carefully and compare interest rates and terms before committing to a loan.

Make sure you understand the repayment terms and obligations before signing any agreement. With the right strategy, a credit builder loan can be a great way to establish a positive credit history and get on the path to financial success.