Bad credit — or no credit at all? This is a unique option to borrow and save at the same time.
A life-changing event, the pursuit of education or an unexpected medical emergency can all stand in the way of an excellent credit score.
Because lenders rely on your credit score to determine if you’ll pay back your debt, your damaged credit history or no credit history at all can narrow your options and make approval difficult. If you’re in this situation, consider a credit-builder loan — a little-known tool designed to establish or boost your credit.
Our guide goes into how credit-builder loans work, where you can get one and what you should consider before applying.
What is a credit-builder loan?
A credit-builder loan is exactly what it sounds like: a loan that helps you build or rebuild your credit. Typically offered by credit unions and banks, they’re loans for small amounts from $500 to $1,500 for people who have bad credit, minimal credit or no credit at all. Even though credit-builder loans are a form of unsecured credit, because you won’t have access to your funds right away, interest rates can be low.
Other names for credit-builder loans:
- Fresh start loans
- Starting over loans
- Savings-secured loans
- Secured installment loans
With a credit-builder loan, your loan money is put into an account that you can’t access until you finish paying off the loan in full. It sounds strange at first, but think of it as a loan layaway. Once your loan is satisfied, you end up with an improved credit score, because you’ve responsibly made payments over the course of 12 to 24 months. And once everything is paid for, you’ll have set aside unrestricted cash in a savings account to use however you wish.
Unlike secured credit cards, credit-builder loans don’t require a deposit — which means you don’t already need savings to get one. And because they’re designed to help people improve their credit, your payments are reported to the three main credit bureaus.
As long as you budget well and deposit your payments on time, this can be an easy, hassle-free way to build a credit history.
Where can I get one?
Credit-builder loans aren’t the most common way to build or rebuild credit, so you’ll have to do a little work on the front end to find a lender offering one. But because they’re a secure, safe means of improving your credit score, they’re worth the extra effort.
Look for a credit-builder loan at:
- Credit unions. A credit union is a nonprofit that offers many of the same services you’ll find at a traditional bank with a few extra — including credit-builder loans. The money you borrow is kept in an account until the end of a term ranging anywhere from 12 to 24 months. Interest rates are generally lower than with other unsecured loans, and many credit unions place your loan in a savings account, where it earns a little extra interest.
- Local banks. Many national banks don’t offer credit-builder loans, preferring that you opt for a credit card instead. But you might find a personal loan with a local bank that secures your funds in an account until the end of your loan term. At this point, you can withdraw the amount you’ve saved or keep it as a nest egg, whichever makes the most financial sense for your situation.
- Online lenders. Online lenders can help you rebuild your credit without visiting a physical location. Businesses like Self Lender work through banks to provide you with small loans that you repay over 12 months. Your loan is secured in a certificate of deposit until it’s paid off, and your payments are reported to the three major credit bureaus.
Benefits and drawbacks
Pros
- End with a nest egg. Because you can’t access your funds until the loan matures, you end up with a decent chunk of change that you can keep in your account for as long as you want. If a financial emergency arises, use your money rather than taking out another loan — a solid way to keep your improved credit score looking good.
- Earn interest on your loan. When your loan is locked in a CD or savings account, you earn interest while you make monthly payments. Interest typically isn’t enough to offset the overall cost of your loan (lenders still have to make money!), but it reduces the total amount you’ll end up paying. Every little bit helps.
- Easy repayment schedule. Nearly all credit-builder loans stretch out monthly repayments over a year or two. Because the amount you borrow is low, so are your payments — meaning you should be able to budget wisely to keep up with them. Review your loan’s terms and conditions — including the loan’s total cost to you — before you sign a contract.
Cons
- You can’t access your money. A definite benefit for many people, your money’s locked away until you satisfy the loan. If you need money right away, a credit-builder loan is not your best option.
- Limited availability. Many banks don’t offer this form of credit, and most credit unions require you to hold an account with them for a few months before they consider you eligible. While they don’t come with as many hoops to jump through, online options are also limited.
- Small loan amounts. Credit builder loans aren’t designed to finance big purchases, like cars or vacations. Expect to borrow up to $1,500 from most lenders.
Public interest in credit-builder loans over time
Over the past four years, people have shown more interest in this loan product. The graph below demonstrates that Google has seen more and more searches for the term “credit-builder loan”, with a peak in 2017.
What other options do I have to borrow money with bad or no credit?
If you can’t afford to wait for your credit-builder loan to mature, you have alternatives that can get you funds within a few days of approval. But these options vary widely in features, eligibility and interest rates.
- Secured credit cards. A secured card functions much like your typical credit card, except that your credit card’s limit — usually up to $500 — is paid by you before you begin swiping. Your deposit acts as collateral, and you can build or rebuild your credit as you pay off your purchases.
- Short-term loans. Payday loans are often considered predatory lending. But by borrowing from a legitimate lender and understanding the full costs, you can get access to small amounts of money to get over a financial hump. If you want to borrow more than a few hundred dollars and need cash quickly, an online installment loan could be an option to consider.
- Bad-credit personal loans. Unlike a standard personal loan, these lenders look beyond your credit history to your income and financial status when determining whether you can afford repayments. They are either single-payment loans or installment loans, and you can borrow money with or without collateral.
- Share- or certificate-backed loans. This type of loan is secured by the funds in your savings or share certificate accounts. The bank will freeze the funds from use and only make them available once your loan payments have been made.
Like many other forms of credit, these options require you to pay back your debts on time through monthly or bimonthly repayments. If you make a late payment or miss one, it can negatively affect your score.
Make sure you can afford to take on extra debt before you agree to a loan. Otherwise, you could find yourself in a debt spiral and worse credit problems than when you began.
Bottom line
Among the many options you have when looking to build your credit score, a credit-builder loan is designed to rebuild your credit while saving unrestricted funds for a rainy day. They’re easy to apply for and a safe investment for your future.
Before you make your final decision, look into other loan options that might be a fit for your needs.