Do Credit Builder Loans Actually Work?

If you have no credit or bad credit, getting a loan may seem impossible.

That’s because when lenders are considering a loan application, their main concern is whether the applicant can pay the loan back. They look at an applicant’s credit history, which shows an one’s debt and payment history, to determine how likely the applicant can pay off a loan in the future.

If an application has no debt — and therefore no loan repayment history, or a spotty record of late payments or loan defaults, a lender likely will determine that lending to the applicant would be too risky.

A credit builder loan is one way you can start building a strong credit history that will eventually qualify you for other loans.

What is a credit builder loan?

How a credit builder loan works

Why your credit score matters

Other ways to build credit

Building good credit, whether you are starting from scratch or repairing a bad credit history, requires patience. You’ll need time to show lenders that you are a consistently reliable borrower who makes on-time debt payments.

A credit builder loan is a great way to begin establishing a good credit history. Here’s how it works:

A financial institution such as a credit union, which typically issues credit builder loans, deposits a small amount of money into a secured savings account for the applicant. The borrower then pays the money back in small monthly installments — with interest — over a set period of time. At the end of the loan’s term, which typically ranges from six to 24 months, the borrower receives the total amount of the credit builder loan in a lump sum, plus any interest earned if the lender offers interest.

Borrowers who make all of their payments on time will benefit significantly. Lenders report the payments to credit reporting companies, which helps the borrower begin build a solid credit history.

A credit builder loan helps consumers build their credit by providing an opportunity for them to make small monthly payments. As the lender reports regular loan payments to credit reporting agencies, your credit history will show that you can make regular, on-time loan payments over the life of a loan.

Most credit builder loans are small, ranging from $300 to $1,000, which means they have also small monthly payments. Interest rates vary by bank, so be sure you compare all your options to get the best rate. We found rates ranging from low as 5% all the way up to 16% at various banks.

To apply for a credit builder loan, consumers can visit a local lender’s branch or apply online. Because the borrower won’t receive any money until the loan is paid in full, credit builder loans typically are easy to qualify for.

Credit builder loans are not free, so be sure to ask about fees and interest rates. Some lenders may charge an application fee, and interest rates vary widely among lenders. While some offer rates in the single digits, other lenders’ rates may be significantly higher.

Here are examples of a few types of credit builder loans.

Credit unionsMany credit unions, which offer credit builder loans as a way to help clients establish good credit, list details of the loans online and provide an online application.

1st Financial Federal Credit Union, for example, offers these terms:

BanksSome regional or local banks, like credit unions, offer credit builder loans with the intention of helping clients build a good credit score as they work toward good financial health.

The Sunrise Banks Credit Builders Program, for example, places loan funds into a Certificate of Deposit (CD) for the borrower. The CD earns interest as the borrower repays the loan, which can be withdrawn when it’s paid in full. Consumers can borrow $500, $1,000 or $1,500, and they are assigned a repayment schedule of monthly principal and interest payments. Payments are reported to Experian, Transunion and Equifax.

The money you put in the CD itself is what secures the loan.

Self Lender offers four loan amounts, each with 12- or 24-month terms. Borrowers can receive loans of $525, $545, $1,000, or $2,200 with interest rates up to 15.65% APR. These terms and rates are current as of Jan. 31, 2018.

Self Lender reviews rate the services as 4.8 out of 5 stars, with many reviewers noting that their credit score increased after paying off their Self Lender loan and praising the platform’s easy and simple process.

Credit scores are calculated from your credit report, which is a record of your credit activity that includes the status of your credit accounts and your history of loan payments. Many financial institutions use credit scores to determine whether an applicant can get a mortgage, auto loan, credit card or other type of credit as well as the interest rate and terms of the credit. Applicants with higher credit scores, which indicate a better credit history, typically qualify for larger loans with lower interest rates and better terms.

Three federal credit bureaus, Equifax, Experian and Transunion, collect information from data providers and lenders, and use it to calculate your credit score. These credit reporting agencies report credit scores to lenders and personal finance websites.

Consumers typically have multiple credit scores, which differ due to the way they are calculated, the information that the credit bureau uses in the calculation and the time that they are calculated. The two major scores are FICO and Vantage.

Here are more details about each one.

FICO scoresFICO scores show the likelihood of a borrower paying back a loan on time, and scores range from 300 to 850. More than 90% of lending decisions in the U.S. are influenced by an applicant’s FICO score.

Five factors determine a consumer’s FICO score:

Vantage scoresVantage scores, which also measure your credit risk, are used by 20 of the 25 largest financial institutions. Like FICO scores, higher scores lead to better loan opportunities. Vanguard scores range from 300 to 850, and are available for free online.

Vantage scores, which are calculated using data from a consumer’s credit report, take six factors into account.

Credit builder loans aren’t the only way to establish a good credit score. Here are some other options if you don’t want to take out a loan.

Many secured credit cards allow you to “graduate” and move to a traditional credit card after you’ve proven that you can make payments consistently. Lenders will report your payments to credit reporting bureaus, and some offer autopay, online payments and alerts to make sure you pay your monthly bill on time.

Secured credit cards are not always free. Some require annual fees and have APRs as high as 25%.

The borrower will receive the money in a lump sum upfront, and a disciplined consumer who is focused on building credit can use the money to repay the loan.

While credit building loans can be a key step in establishing a strong credit history, it’s imperative that you make all of your payments in full and on time. When you are committed to building a strong financial future with personal budgeting and spending discipline, successfully paying off a credit builder loan can lead to approval for good rates and terms on mortgages, auto loans and other loans in the future.