What is a credit-builder loan?

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 $300 to $1,000 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.

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 6 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.

How do I get a credit-builder loan?

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.

Find 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.

Pros and cons

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. This credit product 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 with a secured card 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.

Keep track of your credit score

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Name	Product	Starting price	Trial period	Credit scores	Credit monitoring	Credit reports	Update frequency
Experian Credit Report		$19.99	7 days	TransUnion, Equifax, Experian	Yes	TransUnion, Equifax, Experian	Monthly, Annually	Get your credit report and FICO score for just $1 with enrollment in Experian CreditWorks credit monitoring. Cancel anytime.	Go to site More Info		loading Fetching your data...
TransUnion Credit Report		$24.95	No	TransUnion, Equifax, Experian	Yes	TransUnion, Equifax, Experian	Monthly	TransUnion credit score, monitoring and identity theft insurance.	Go to site More Info		loading Fetching your data...
myFICO		$19.95	No	TransUnion, Equifax, Experian	Yes	TransUnion, Equifax, Experian	Monthly	Get quarterly access to your most widely used FICO® Scores and a 3-bureau credit report.	More Info		loading Fetching your data...
Equifax Small Business Credit Reporting		$99.95	No	TransUnion, Equifax, Experian	Yes	TransUnion, Equifax, Experian	Annually	Monitor your key business relationships to protect your company from losses.	More Info		loading Fetching your data...
GoFreeCredit.com		$24.95	7 days	TransUnion	Yes	TransUnion	Monthly	$1 for a seven-day trial to get access to your credit score and credit report from TransUnion.	More Info		loading Fetching your data...
Credit Karma		$0	No	TransUnion, Equifax	Yes	TransUnion, Equifax		More Info		loading Fetching your data...

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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.

FAQ

• Are there other ways to build my credit score?

  In addition to the options listed above, you may want to address any underlying issues that led to your financial situation. For example, credit counseling can help you learn how to manage your overall finances. Understanding how the system works and how you can make a budget for your expenses, no matter your income, can help you avoid future problems and improve your credit score.

• How long will it take to improve my credit score?

  With a credit-builder personal loan, you could see an improvement in your credit score from six months to a year after taking it out. The jump may be small — typically only 20 to 25 points. But that jump can make a big difference when it comes to the interest rates banks and other financial institutions will be willing to offer you for future larger loans.

• Why haven't I heard about a credit-builder loan before?

  If you haven’t yet heard of this type of lending, it’s probably because not all banks or credit unions offer them. If they do, they could call them something other than credit-builder loans — like “savings-secured loans” or “secured installment loans.”

  If you’re not sure whether your current financial institution offers one, just ask — you might be surprised to learn it’s another financial tool in a suite of financial services available to you.