Is A Credit Builder Loan Right For You?

Most people generally understand that their credit score is important. However, you might not realize how important it is until you go to apply for a mortgage or another type of loan. Getting denied for a loan or paying a much higher interest rate can really drive the point home.

Whether you have bad credit from your past, or you have no credit history, the good news is that your credit score can be improved. Credit builder loans were designed to help people do just that. We’ll explain how they work, who they work best for and the potential benefits and risks.

What Is A Credit Builder Loan?

Credit builder loans are special loans created specifically to help people improve their credit scores. They're different from traditional loans in that the money you borrow is held in a lender-controlled account until you’ve paid off the loan, rather than immediately disbursed to you.

The lender holds on to the money while you make payments every month. The lender will report the on-time payments that you make to the credit bureaus, which becomes a record of you handling a loan responsibly. This can improve your credit score over time.

Lenders holding the funds while you pay the loan back are protected from the risk of lending money to applicants with higher risk profiles, namely, those with bad credit or no credit history. Once you’ve paid off the loan in full, the lender will give you the funds.

Who Should Consider Credit Builder Loans?

You could see benefits from credit builder loans if any of the following criteria apply to you:

• Credit invisible: According to the National Credit Union Administration, this is the official term for those with no credit scores because they either don’t have a credit history or it’s extremely limited. Credit builder loans can be a great opportunity to start building a positive history.
• Struggling to qualify for a mortgage: To qualify for a conventional mortgage, you need a credit score of 620 or higher. The minimum threshold can change depending on the type of mortgage you apply for, but in most cases there will be a minimum score you need to hit. Credit builder loans can help bridge the gap if you need to hit a certain number.
• Have bad credit: Even if you aren’t currently looking to shop for anything requiring a loan, improving a bad credit score will help you in the long term. Starting the process now can expedite improving your credit score and save you headaches in the future.
• Want to save and improve credit: Simply depositing money into a savings account each month won’t affect your credit score. Because credit builder loans release the funds to you after you’ve paid them back, these loans can be a good way to eventually increase your savings, while also getting the benefit of improving your credit score.

Credit Builder Loan Structure

Now that we’ve covered what these loans are and who they typically work best for, let’s get into the specifics of the loan itself.

Loan Amount

How much can you borrow? That will ultimately depend on where you get the loan from. Generally speaking, most of these loans range from $300 – $1,000.

You may be able to find lenders that offer loans for higher amounts but remember, the main purpose of the loan is to build your credit.

Loan Term

Most loan terms usually range from 6 – 24 months. Keep in mind that you’ll be responsible for paying interest as part of your monthly payment. The longer your loan term, the more you’ll end up paying in interest over the life of the loan.

Alternatively, choosing a shorter loan term will save you in interest, but your monthly payment will be higher. Regardless of the loan term you select, if you make payments on time and in full, you should see an improvement in your credit score within a few months.

Annual Percentage Rate

Annual percentage rate (APR) is the metric that shows you the total cost of borrowing money for a year. It includes both the interest rate the lender charges as well as any fees included. The interest rate and fees you’re charged will depend on which lender you use.

APR percentages can vary widely depending on when you apply for the loan, the lender you use and your financial circumstances. That said, it’s common to see APRs range anywhere from 6% to 16%.

Pros And Cons Of Credit Builder Loans

As with any financial decision, there are potential benefits and risks that should be considered. We put together some of the most important factors to consider so you can weigh them for yourself.

Pros

• Get a credit score: According to a study by the Consumer Financial Protection Bureau (CFPB), participants without a credit score who took out a credit builder loan increased their likelihood of having a credit score by 24%.
• Improve your credit score: Establishing a history of on-time and in full payments can significantly increase your credit score and is one of the main appeals of this loan program.
• Easier qualification: Because the program was designed to help those with credit struggles, it can be easier to qualify for these loans, and some lenders won’t even run a credit check.
• A way to save: According to the CFPB study, participants who took out a credit builder loan saw their savings increase by an average of $253.

Cons

• You can hurt your credit score: In order to help your credit score, you need to repay the loan on time. If you don’t, you can actually hurt your credit score.
• You don’t get money right away: You need to pay off the loan in full in order to receive the funds. That means if you actually need the money to cover an expense, it won’t be of any use to you until the loan is repaid.
• Takes time to see improvement: Even with making on-time repayments, credit score improvement won’t be instantaneous. It can take a few months to start to see the results.
• You’ll pay interest and fees: Borrowing money isn’t free. You’ll be paying interest and fees to your lender, so it will cost you money in order to have the chance to improve your credit.
• Can be hard to find: Most major banks and the biggest online lenders don’t usually offer these types of loans.

How To Find Credit Builder Loans

Most major banking providers don’t offer credit builder loans. This is because they are usually for small amounts, especially compared to mortgages or personal loans, and are designed to help people with credit issues.

Your best bet is to look locally, both at credit unions and community banks.

Alternatives To Credit Builder Loans

If you decide that a credit builder loan isn’t right for your situation, don’t worry, there are still plenty of other options for improving your credit.

Secured Credit Card

These function similarly to unsecured credit cards, but banks require a security deposit upfront. This will give you access to a line of credit that you can now use like any other credit card. Just be sure to make the minimum payments on time, and it’s better if you pay off the balance in full each month.

Authorized User Status

People who care about you, such as friends and family, can help you build your credit by adding you as an authorized user on their credit card accounts. This allows you to make purchases with their account, but the shared responsibility can boost your credit score. Be warned: if you miss payments, the primary account holder’s credit will suffer; the opposite is true, too, for you if the primary card holder does not make payments on time.

Personal Loan

If you’re in a position where you need to build credit, a personal loan is another possible option. With a secured loan, you’ll need to put some collateral down to reassure the lender. Common examples of collateral include vehicles, homes and savings accounts. Repaying the loan will improve your credit score, but if you can’t repay it, your score will be negatively affected and the lender will take possession of your collateral.

FAQs About Credit Builder Loans

Here are some frequently asked questions about credit builder loans.

How fast will my credit improve, and by how much?

It usually takes a few months for your credit score to improve. Remember, your credit will only see improvement if you make your monthly payments on time. As for how much your score may improve, according to the study by CFPB, opening a credit builder loan could have an effect of up to 60 points. That’s a significant change and could make a big difference down the road.

Are credit builder loans worth it?

That’s entirely up to you. If you’ll have difficulty repaying the loan, then no, it’s probably not worth it and it could end up hurting your credit score. Remember, you will pay fees and interest on top of paying back the money you borrow. However, if you can stay disciplined and make your payments on time, you can end up with a lump sum boost to your savings down the road and an improved credit score.

How much can I get with a credit builder loan?

Credit builder loans usually come with lower limits than personal loans. Most of them are for less than $1,000, although you may be able to find a lender willing to offer you more.

What happens if I don’t pay a credit builder loan back?

If you miss a payment, the lender will most likely report it to the credit bureaus, which will negatively impact your credit score. You also won’t have access to the funds in the account until you’ve repaid the loan in full.

The Bottom Line

There’s no question that credit builder loans are a viable path toward improving your credit. Just remember, they only work if you commit to making payments on time. If you’ve decided a credit builder loan isn’t right for you, consider getting a personal loan from Rocket Loans^SM and get started establishing a solid credit history today.