Are you looking to build or repair your credit? A credit-builder loan may be worth considering since it’s designed to build your credit profile or increase your credit score.
They’re ideal for credit newbies and those looking for a fresh start. Credit-builder loans also work for cash-strapped consumers since they don’t require a security deposit.
How Credit-Builder Loans Work
Credit-builder loans function like installment loans, but they’re designed to help you establish or improve your score. For this reason, the loan amounts tend to be much lower than what you’d with other loan products to help ensure the borrower can afford to make the monthly payments.
Here is a list of the benefits and the drawbacks to consider.
- Easier to qualify for than an unsecured personal loan
- Funds are placed in an interest-bearing savings account, so you’ll earn money as you pay down the loan balance
- Smaller loans may be more affordable than a secured credit card
- Payment activity reported to the credit bureaus
- Funds can’t be accessed until loan is paid off
- You’ll pay interest on funds that aren’t yet yours. But in some instances, the interest is refunded at the end of the loan term.
Types of Credit-Builder Loans
Traditional Credit-Builder Loan
When you take out a standard credit-builder loan, you don’t get the money upfront. Instead, the lender opens a savings account and deposits the loan proceeds. This serves as collateral in the event you default on the loan.
Once you’ve paid the balance in full, you can withdraw the money plus interest. Even better, payments are reported throughout the life of the loan, so your payment history will receive a boost.
To illustrate, if you take out a credit-builder loan from Self Lender, you will make monthly payments of $48.50 for 12 months. And at the end of the loan term, you’ll receive $550 plus interest.
Secured Credit-Builder Loan
If you already have money in the bank, you may be able to take out a loan against your own money. You can expect a lower interest rate since the funds that are held as security are your own and are frozen until the loan is paid in full.
Unsecured Credit-Builder Loan
Unlike traditional credit-builder loans, unsecured credit builder loans allow you to get the cash upfront. However, they may come with steeper interest rates to help the lender hedge against the risk of default.
Who Offers Credit-Builder Loans?
You can check with traditional brick-and-mortar banks. But you may have more luck with local credit unions, community banks, and online lenders. The St. Mary’s Bank, Achieve Financial Credit Union, and GTE Financial are just a few of the financial institutions that offer credit-builder loans.
Use SuperMoney’s personal loans reviews and comparison tool to find more options.You can also view a nationwide directory of credit-building programs at Consumer-Action.org.
What Happens If I Default On the Loan?
If you don’t pay on time, late payments get reported to the credit bureaus. The good news is you have 30 days before this happens, but you should call the lender right away if you know you’re going to be late. You could also lose your chances of getting the cash in the account at the end of the loan term.
Alternatives to Credit-Builder Loans
There are some other effective ways to establish or rebuild your credit.
Secured Credit Card
If you have the cash on hand but prefer not to apply for a credit-builder loan, consider a secured credit card. Once you make the security deposit, the minimum payment is based on how much you spend. Payment activity is reported to the credit bureaus to help you start rebuilding your score. And once you’ve demonstrated that you can manage the card, you may be able to graduate to an unsecured card.
Become an Authorized User
You can also become an authorized user on someone else’s credit card to build credit. Keep in mind your credit score can also be affected negatively if the primary user doesn’t pay on time or racks up a high credit card utilization ratio. But, responsible card use and timely payments can provide a boost to your credit score.
How to choose a credit-builder loan
When considering your options, read the fine print. Be mindful of the loan term and interest rate. Also, pay attention to the monthly payment. If it’s too high, you run the risk of defaulting on the loan and doing further damage to your credit score. Most importantly, confirm that the lender reports payment activity to the credit bureaus.
If you need a loan, make sure you shop around for the best rates. SuperMoney’s loan comparison tool lets you get competing personal loans from multiple vetted lenders without huring your credit score.
Allison Martin is an accomplished finance writer who has written for publications including The Wall Street Journal, MoneyTalksNews, The Simple Dollar, and Credit.com. Her work has been featured on Fox Business, Yahoo! Finance, MSN Money, and ABC News. She enjoys writing about personal development, entrepreneurship, personal finance and is a Certified Financial Education Instructor (CFEI).