Credit Builder Loans: The Definitive Guide

what's a credit builder loan?

By Zina Kumok

If you're new to credit, or trying to rebuild your credit but struggling to gain acess to the right tools, a credit builder loan might be just the ticket.

Read this guide to learn:

So if you're new to credit or have bad credit and you're looking for ways to improve your credit, this guide is for you.

Let's get started!

What is a credit builder loan?

A credit builder loan is an installment loan that exists for the sole purpose of helping build credit.

The main difference between credit builder loans and other types of loans is that you don't get the money until you've finished repaying the loan.

By holding onto the loan funds as you make payments, the lender is able to avoid any risk while you prove yourself a reliable borrower.

Here’s how it works:

  1. You apply for and open a credit builder loan at a bank, credit union or through Self. Sometimes they're also called share secured loans.
  2. When your application is granted, the financial institution moves the loan proceeds you were approved for into a separate account, usually a savings account or certificate of deposit (CD). The loan amounts tend to be between $300 and $1,000, though some banks offer credit builder loans as high as $2,500.
  3. You then begin making your monthly payments for the predetermined amount of time. Loan terms can be as short as six months or as long as six years.
  4. The bank, credit union or service provider reports your monthly payment activity to one or more of the three major credit bureaus (Experian, Equifax, Transunion)
  5. Once the loan balance reaches zero, the service provider unlocks the CD or savings account and returns the total money the borrower paid, minus any interest and administrative fees.

Who should get a credit builder loan

The people most likely to benefit from a credit builder loan are those with a very poor or fair FICO credit score. FICO defines a poor credit score as 580 or below and fair as 580-669. People with a starting credit score below 600 are more likely to see a positive impact from a credit builder loan over time, according to analysis of Self customer data.

This includes people who are new to credit, who may not even have a credit score yet because they have no credit history.

If you already have an installment loan that reports to the credit bureaus and is showing on your credit report, you might not need a credit builder loan.

Other types of installment loans typically include:

  • Student loans
  • Car loans
  • Mortgages
  • Personal loans

Learn how to read your credit report here.

If you don't already have an installment loan, but you have a credit card, you may still benefit from a credit builder loan. That's because the credit scoring models place some value on your ability to manage different types of credit.

How credit builder loans affect credit score

While you’re making loan payments, the lender should report your payment activity to all three credit bureaus:

  • Experian
  • Equifax
  • TransUnion

Your payment history counts for 35% of your FICO credit score. That's the single most important factor.

If you make your payments on time and in full each month, this should help build positive payment history with the major credit bureaus, and could improve your credit score over time.

Opening a credit builder loan can help you build this payment history, since part of the process involves making monthly payments.

Like any financial product, a credit builder loan is a tool, so how you use it matters. If you make payments on time, the lender will report positive payment history to the credit bureaus.

If, on the other hand, your payments are late or not for the full amount, your lender reports that to the credit bureaus, too, which could lower your credit score.

Because most credit builder loans have a term of 12 months or more, you’ll have a solid history of on-time payments once your credit builder loan is completed.

That improved credit history can make it easier to access to other credit products (like credit cards or car loans) and better interest rates on those credit products.

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Where to get a credit builder loan

Because a credit builder loan is designed for those with no credit, you don’t need a good score to be eligible. You can even apply if you don’t have any credit history at all.

You typically just have to:

  • Be at least 18 years old
  • Be a US citizen or permanent resident
  • Have a Social Security number
  • Have a bank account, debit card or prepaid card
  • Live in one of the 50 US states

If you’re reading this article, chances are you would have no problem qualifying for a credit builder loan.

You can find a credit builder loan through certain community banks, local credit unions or at Self, which is available online or via mobile app in all 50 states.

Just remember to compare terms and shop around when looking for a loan.

Why pick a credit builder loan?

By typically having a low annual percentage rate, relatively small loan amounts and relatively brief loan terms, credit builder loans are designed to increase the likelihood that you can repay the loan and build positive credit.

You still have to be responsible when using a credit builder loan.

If you miss a payment, the lender will have to report that to the credit bureaus, just as it would your on-time payments. If you don’t have a long credit history, one late payment can make a huge impact.

To avoid late payments, set up automatic payments from your bank account to your credit builder loan. Check to make sure the monthly payment went through, and use calendar reminders as an extra precaution.

This can help get you on the right track towards being a responsible borrower and establish good habits to use for your next secured loan.

Other ways to build your credit

Credit builder loans are just one tool that could improve your credit. A secured credit card is another popular way to build credit.

Unlike traditional credit cards, a secured card requires a deposit to act as collateral. Usually the deposit is small, between $200 and $2,000. The deposit will equal the card’s credit limit, and you have to submit the deposit before you get the card.

You can use a secured credit card online and at retailers just like any other credit card.

Just make sure the provider reports to all three credit bureaus if you want to build credit.

After a few months of using the card responsibly, the provider may upgrade you to a traditional credit card, so you can get your security deposit back.

If you’re going to use any type of credit card, just remember to use your credit wisely.

Your credit utilization percentage makes up 30% of your total credit score, making it the second highest factor in determining your score.

Since secured credit cards often have lower credit limits, it’s easy to use more than 30% of the available credit line. Many credit experts advise people to keep credit utilization below 30% to maintain or improve their credit score.

To illustrate the credit utilization, if you have a credit card with a $200 credit limit, then having a balance of more than $60 brings your utilization over 30%.

You can rack up that amount easily just with one trip to the grocery store. Be sure to monitor your usage carefully.

The other major consideration with any credit card is interest. If you don’t pay your balance in full by the due date, you’ll be charged interest.

Secured credit cards often have higher interest rates than traditional credit cards because they are being offered to people with low credit scores, so this mistake can be costly.

About the author

Zina Kumok writes extensively about personal finance with a focus on budgeting and debt elimination. Her work has appeared in publications as diverse as Forbes, Mint and LendingTree.

Written on April 3, 2019

Self is a venture-backed startup that helps people build credit and savings.
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Disclaimer: Self is not providing financial advice. The content presented does not reflect the view of the Issuing Banks and is presented for general education and informational purposes only. Please consult with a qualified professional for financial advice.

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