What is a Credit Builder Loan?

A credit builder loan is designed to boost your credit if you show you’re responsible for making on-time payments. Once you repay the amount you borrowed, you’ll receive all the money back from the lender plus any earned interest and enjoy a savings boost as well.

You might wonder, “Why would I need to take out a credit builder loan in the first place?” To build credit, you need credit, and a credit builder loan provides the perfect opportunity to improve your credit score and use the money you saved in the end for an emergency fund, to pay off debt, or to have a fun weekend getaway.

What is a Credit Builder Loan?

A credit builder loan is a type of loan designed specifically to help improve the user’s credit history and credit score. It is a type of loan where the user deposits the principal amount first and then improves their credit by making regular on-time payments.

So unlike traditional loans where a credit limit is provided to the borrower first and then the borrower pays off the principal amount plus interest, a credit builder loan has the user deposit the principal amount first, and then the user makes on-time payments to show a positive payment history. 

How Does a Credit Builder Loan Work?

Unlike a traditional loan, where you receive the money upfront and make payments over time, a credit builder loan works in reverse. With a credit builder loan, the lender holds the loan amount—typically between $300 and $1,000—in a secure savings account or certificate of deposit (CD) that the borrower cannot access until the loan is fully repaid.

Here’s what you can expect once you’re approved for a credit builder loan:

• Your lender sets aside the funds. The loan amount is held by your lender in a secure account. In some cases, this money may earn interest, depending on the account type and the lender's terms.
• You make monthly payments with interest. Over a fixed term, usually between 6 to 24 months, you make scheduled payments. These payments include both principal and interest charges, which are outlined in your loan agreement. This interest is what you pay to borrow the money, even though you don’t have access to it yet.
• Your payment history is reported to the credit bureaus. Each on-time payment is reported to one or more major credit bureaus, which can help you build or improve your credit score.
• You receive the funds at the end of the loan term. After you’ve made all your payments, the lender releases the full loan amount to you. Depending on the account type, you might also receive any interest earned on the deposited funds, separate from the interest you paid as a borrower.

This structure is what makes a credit builder loan unique: you're essentially paying into a savings account while building your credit at the same time. However, it's important to note that you do pay interest for the opportunity to build credit, so understanding the total cost of the loan is crucial.

A Real-World Example

Let’s say you’re approved for a $1,000 credit builder loan at a 6% interest rate with a monthly compounding frequency (the number of times you earn interest on your interest), and the lender stores this amount in a certificate of deposit. 

Before you receive this money, you must make payments over 24 months to prove you’re responsible with money. After you’ve paid everything in full over the 24-month repayment period, you’ll receive the original $1,000 and the $127.49 in interest earned over the two years, leaving you with $1,127.49. 

Where to Find Credit Builder Loans

You can find credit builder loans online or through a local financial institution. Here are a few places you can look to see if they offer a credit builder loan:

• Local credit unions: Most provide lower interest rates and flexible options. 
• Community banks: These may require you to have a savings or checking account with them. 
• Large banks: Ideal if you already have an account or want to have one with a large bank like Wells Fargo or U.S. Bank. 
• Online loan lenders: Conduct an online search to discover loan options available in your state.  

How to Get a Credit Builder Loan

If you’re interested in getting a credit builder loan, here are the steps you need to take to secure a loan and build your credit: 

• Step 1: Find a lender & compare loans. Research different credit builder loan rates and amounts between local credit unions, community banks, online lenders, or large banks to select a loan compatible with your budget. 
• Step 2: Check your eligibility. Share your contact information with your preferred lender, including your Social Security number. You may also need to show proof of income and potentially open a checking or savings account, depending on the lender you choose. 
• Step 3: Apply. Apply for the loan amount you need and select your loan term, commonly between 6 and 24 months. 
• Step 4: Make monthly payments. Pay back the original loan amount and additional interest each month of your loan-term agreement with automatic payments. 
• Step 6: Review your credit often. Check your credit occasionally to keep track of your progress.
• Step 5: Get your money back. Be rewarded for your patience and dedication with a healthier credit score and your money back. 

Is it Difficult to Qualify for a Credit Builder Loan?

Qualifying for a credit builder loan is actually pretty simple since this loan is designed for borrowers who need to improve their credit. The sole purpose of a credit builder loan is to help you build credit, not punish you for not having any. Also, since you're responsible for paying the principal loan amount upfront, not the lender, the lender takes on less risk with a credit builder loan. 

Who Can Benefit From Credit Builder Loans?

Credit builder loans can be a helpful financial resource for many, especially those wanting to improve their credit and save money. They’re made to work for you, not against you, as you work toward a healthier financial future. 

Here are a few types of people who could benefit from a credit builder loan. 

Those Who are Credit-Invisible 

If you’ve never owned a credit card or taken out a loan, you might be what lenders call “credit-invisible.” This means that even though you have a checking or savings account, there’s no record of you borrowing money. Without a history of borrowing, it can be difficult to qualify for car loans, a mortgage, or even a rental application.

A credit builder loan helps you make yourself visible to lenders and establish a credit history. Since lenders keep track of your payments and report them on time to the major credit bureaus, you can show proof of being financially responsible when you apply for future financial opportunities. 

Those With a Thin Credit File

If you have some credit history but not enough to improve your credit score or qualify for a competitive rate, you may have a “thin credit” file. Maybe you took out a personal loan a few years ago or had a temporary credit card, but when you applied for another loan, the lenders didn’t see enough credit to determine if you were responsible. 

A credit builder loan can thicken your credit file with a new account and a healthy payment history. This mix of credit can improve your score over time and show lenders you can handle credit responsibly. 

When a Credit Builder Loan May Not Make Sense

While a credit builder loan may be a smart way to make yourself visible to lenders and credit bureaus, there are a few cases in which a credit builder loan may not be a great idea. 

Here’s when you might need to rethink your decision about applying for a credit builder loan and consider an alternative: 

• You already have a healthy credit history.
• You aren’t in a financial situation where you can make payments.
• You need cash quickly. (If this is the case, consider a payday loan to spot you until your next paycheck.)
• You’re working on getting yourself out of debt. 

What are Other Options for Building and Rebuilding Credit?

If a credit builder loan isn’t a suitable financial option, but you’re still looking to improve your credit, don’t worry. There are other options for building and rebuilding your credit to consider. These include: 

• Authorized credit card user: A trusted family member or friend can add you as an authorized user on their credit card. This can benefit you and the primary cardholder’s credit score if both parties have a healthy payment history. 
• Secured credit card: If you have little or poor credit, a secured credit card is a great way to recover from a financial setback. Instead of a traditional credit card, a secured credit card requires you to put down a refundable deposit. This deposit acts as your spending limit. Every time you use your secured credit card, the bank will notify the credit bureaus to help build your credit. 

Store credit card: If you shop frequently at specific places then signing up for a store credit card might be a great option. Unlike traditional credit cards, store credit cards are easier to qualify for and have lower limits. However, they have higher interest rates, so paying off your balance in full each month is important if you plan to apply for a store credit card.