Your credit score plays an important role in your financial life. If you have good credit you can qualify for loans and borrow money at lower interest rates. If you don’t have a credit score or have poor credit, it can be hard to get loans and you’ll be forced to pay higher rates when you do qualify.
Building credit can be like a chicken and egg problem. If you have no credit or bad credit, you’ll have trouble getting a loan. At the same time, you need to get a loan so you have an opportunity to build credit.
What Is a Credit Builder Loan?
A credit builder loan is a special type of loan designed to help people who have poor or no credit improve their credit score.
In many ways, credit builder loans are less like loans and more like forced savings plans. When you get a credit builder loan, the lender places the money in a bank account that you cant access. You then start receiving a monthly bill for the loan. As you make those payments, the lender reports that information to the credit bureaus, helping you build up a payment history. This improves your credit score.
Once you finish the payment plan, the lender will release the bank account to you and stop sending bills.
In the end, you’ll wind up with slightly less money than you paid overall, due to fees and interest charges. For example, let’s say you get a credit builder loan for $1,000, the lender may make you make a monthly payment of $90 each month for a year. After the year ends, you’ll get the $1,000 from the lender, but may pay $1,080 overall.
Why Get a Credit Builder Loan?
The main reason to get a credit builder loan is right in the name: They help you build your credit. If you don’t have any credit history or if you’ve damaged your credit by missing payments, it’s much easier to qualify for a credit builder loan than a traditional loan from a lender.
The companies offering credit builder loans take on almost no risk because they don’t give you the money until you’ve finished paying the loan, so they’re willing to approve people who have severely damaged credit.
Credit builder loans will help you build your credit history if you make your monthly payments, but you do have to pay fees and interest to do so. There are other ways to build credit that don’t require paying any money. For example, if you get a fee-free credit card and pay your balance in full each month, you’ll build credit without paying any interest or fees.
This makes credit builder loans best for people who have tried and failed to qualify for other loans and credit cards.
There is also some value in the forced savings provided by credit builder loans, but the interest and fees eat away at that savings. If saving is your goal, it’s best to use a different strategy to help you save, but if you want to save and build credit at the same time, a credit builder loan might be worth using.
Where to Find Credit Builder Loans?
There are many companies that offer credit builder loans. Each lender offers different loan terms, fees, and interest rates.
One of the top credit builder loan providers is Self. The company offers credit builder loans with payment plans as low as $25 per month, making it easy for almost anyone to afford a credit builder loan.
With Self, you can also qualify for a Visa credit card after you’ve made at least 3 payments on your credit builder loan and made $100 of progress toward paying off the loan. You can set your own credit limit, up toward the total amount of progress you’ve made on the loan.
The card doesn’t have any additional upfront costs and can help you gain experience with using a credit card. It can also help you build your credit by giving you another account to make payments on, providing you with more opportunities to build a good payment history.
What to Look for?
When you’re looking for credit builder loans, there are a few factors to consider.
The first thing to think about is the monthly payment. The point of a credit builder loan is to show the credit bureaus that you can make regular payments on your debts, which will help build your credit score. If a lender’s minimum payment is more than you can afford each month, you won’t be able to build your credit with that lender’s credit builder loan.
It’s also important to think about the cost of the loan. Credit builder loans often come with stiff fees and you also have to pay interest on the money you’ve borrowed, even if you don’t get access to it until you pay the loan off.
The fewer fees and the less interest you have to pay, the better. You should look very carefully at each lender’s fee structure to choose the best deal.
Finally, take some time to see how easy it is to qualify. While credit builder loans are targeted at people with bad credit, some lenders will still check your credit history and might deny your application.
If you have very bad credit, you might want to look for a lender that advertises credit builder loans with no credit check.
Alternatives to a Credit Builder Loan
Credit builder loans can be a good way to build credit for some people, but they come with interest charges and fees. There are other ways you can build credit worth considering. Some of them won’t cost any money, which may make them a better choice than a credit builder loan.
Secured Credit Cards
A secured credit card is a special type of credit card that is much easier to qualify for than a typical card.
With a secured card, you have to provide a security deposit when you open the account. The credit limit of your card will usually be equal to the deposit you provide. For example, if you want a $200 credit limit, you’ll have to give the card issuer $200 as collateral.
Because you give the lender cash to secure the card, it’s much easier to qualify for a secured credit card. The lender assumes almost no risk. Once you get the card, it works like any other credit card. You can use it to spend up to your credit limit and you’ll get a bill each month. If you pay the bill on time, you can build credit.
Many secured cards charge high-interest rates and have hefty fees, but there are some fee-free options available. One great secured card is the Discover it® Secured Credit Card, which has no annual fee and offers cash back rewards.
Become an Authorized User
Most credit card issuers let cardholders add other people as authorized users on their accounts. Authorized users get their own cards and can use them to spend money just like the main cardholder.
Some issuers will report account information to the credit reports of both the main cardholder and any authorized users. If you know someone that is willing to make you an authorized user on their credit card account, this may help you build your credit so you can qualify for a card of your own.
Not every issuer will report information to authorized users’ credit reports. It’s also worth keeping in mind that if you become an authorized user on a card and the cardholder stops making payments or racks up a huge balance, that will show up on your report as well, damaging your credit further. That can make this strategy risky.
Personal Loans with a Cosigner
Personal loans are highly flexible loans that you can use for almost any reason. If you need to borrow money, you can try to find someone who is willing to cosign on the loan. Having a cosigner can make it easier to qualify, even if you have poor credit, giving you a chance to build your credit score.
When someone cosigns on a loan, they’re promising to take responsibility for your debt if you stop making payments. Lenders will look at both your credit and your cosigner’s credit when you apply, so having a cosigner with strong credit can help you get the loan or reduce the interest rate of the loan.
Keep in mind that your cosigner is putting themselves at risk by cosigning on a loan. It’s even more important that you make your payments every month. If you don’t, your cosigner will have to pick up the slack.
Personal Loans without a Cosigner
Even if you have poor credit, you may be able to qualify for a personal loan designed for people that don’t have strong credit. Just keep in mind that you’ll have to pay higher fees and interest rates to compensate for your poor credit score.
If you’re looking for a personal loan and have poor credit, shopping around for the best deal becomes even more important. You can use a loan comparison site, like Fiona, to get quotes from multiple lenders so you can find the cheapest loan.
Related: Best Emergency Loans for Bad Credit
What Is the Difference Between a Credit-Builder Loan and a Personal Loan?
A personal loan is a type of loan that you can get for almost any reason, such as consolidating debts, starting a home improvement project, paying an unexpected bill, or even going on vacation. They’re offered by many lenders and banks.
A credit builder loan is less a loan and more a forced saving plan. When you get a credit builder loan, the lender doesn’t actually give you any money. Instead, it places the amount you’re borrowing in an account you cant access. Once you finish paying the loan, the lender releases the money in that account to you.
Credit builder loans tend to be much easier to qualify for than personal loans because the lender doesn’t have to take on much risk. They’re mostly used by people who want to build or rebuild their credit score.
On the other hand, personal loans are less popular for building credit and more useful for providing funding when borrowers need cash to cover an expense.
Pros and Cons of a Credit Builder Loan
Before applying for a credit builder loan, consider these pros and cons.
Easy to qualify for
Helps you build savings
Payments are usually small
Helps you build payment history
Not really a loan
Fees and interest rates can be high
There are cheaper alternatives to build credit
These are some of the most frequently asked questions about credit builder loans.
Can You Repay a Credit Builder Loan Early?
Like most loans, it is possible to repay a credit builder loan ahead of schedule, but there are a few downsides to consider. One is that many lenders add an early repayment fee to their loans, so you’ll have to pay that fee if you want to get out of the credit builder loan. The other is that repaying the loan early somewhat defeats the purpose. Each monthly payment you make toward the loan helps you build your credit. If you pay the loan off early, you’ll make fewer monthly payments, which means less improvement in your credit.
What Happens If I Miss a Payment on a Credit Builder Loan
Missing a payment on a credit builder loan is like missing a payment on any loan. You’ll likely owe a late fee and it will damage your credit. This is one of the reasons it’s important to make sure you can afford the monthly payment before signing up for a credit builder loan. If you can’t make your payments, the loan will wind up damaging your credit instead of helping it.
Credit builder loans can be a good way to build or rebuild your credit, but they’re not your only option. They often involve paying fees and interest, so you should search around for the best deal or look for cheaper (or free) alternatives, such as secured credit cards.