How to get a credit-builder loan

A credit-builder loan is a financial product used to — as the name implies — help someone establish or build credit.

Unlike traditional personal loans, credit-builder loans aren’t necessarily designed for folks who need to borrow money for a big or unexpected expense. Rather, they make it easier for borrowers to repair their existing credit while also building savings.

Here’s how credit-builder loans work, how to get one and some alternatives to consider if you’re trying to build credit.

• What is a credit-builder loan?
• How does a credit-builder loan work?
• How to get a credit-builder loan
• How much does a credit-builder loan cost?
• Alternatives to credit-builder loans

What is a credit-builder loan?

With a standard personal loan, a lender gives you money up front, which you repay in a series of installments until the debt is satisfied.

With a credit-builder loan, however, the lender doesn’t disburse upfront funds. Instead, the lender will hold the money in a designated account (where it may or may not accrue interest) until you repay the loan amount.

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How does a credit-builder loan work?

A credit-builder loan operates in reverse order compared to a traditional loan:

• After getting approved for a credit-builder loan, your lender will deposit the money you want to borrow in a bank account that it holds. The lender doesn’t disburse this money to you.
• You’ll then make monthly payments on the loan as scheduled, just like with a personal loan, typically over six to 24 months. The difference, of course, is that you’re making monthly payments on money you don’t actually have in-hand and can’t yet touch.
• As you make your payments each month, your lender will report your payments to the credit bureaus. They can choose to report to one, two, or all three agencies, which include Equifax, Experian, and TransUnion.
• Making on-time payments will help establish your credit history (if you have little or no credit) or increase your existing score.

These reported payments will help build up the payment history portion of your credit report, as well as boost your average age of accounts and your credit mix, which can all improve your credit score over time.

Once you’ve repaid the loan, the lender will give you the money that was held in your credit-builder account. You can then use that money as an emergency savings account, to pay off credit cards, or to cover large or unexpected expenses.

How to get a credit-builder loan

If you’re interested in applying for a credit-builder loan, follow these four steps:

1. Find a lender that offers credit-builder loans. Compare credit-builder loans from at least a few different lenders. Look at the loan amounts they offer, interest rates and repayment terms. This will allow you to find the most cost-effective loan for your needs.
2. Make sure you meet eligibility requirements. Qualifying for a credit-builder loan is usually easier than taking out a standard personal loan, as the lender takes on less risk by holding onto the borrowed amount. But you may still need to meet certain requirements related to your age, income, citizenship and location. If the loan is offered by a credit union, you may also need to become a member to take out a loan.
3. Apply for the loan. Once you’ve found a competitive credit-builder loan product that meets your needs, it’s time to apply. You may need to provide additional documentation to verify your identity and income.
4. Start making payments. Once your loan is finalized, you’ll start making payments to your lender as agreed. At the end of the loan repayment term, you’ll receive the funds.

How much does a credit-builder loan cost?

The cost of a credit-builder loan comes down to interest and time.

These loans — like personal, auto, and student loans — come with an interest rate. This is the lender’s fee for lending this money to you, expressed as a percentage. Credit-builder loans are less risky to lenders than immediate-disbursement loans, so they often come with lower interest rates. This can save you money over the course of the loan term.

For some borrowers, though, time may be the bigger cost. Since credit-builder loans aren’t disbursed until the debt is satisfied, you’ll be paying down the balance of a loan you haven’t actually received. If you need that money for consolidating other debt, paying off a big expense, or building emergency savings, you’ll have to wait up to 24 months to access that money.

Alternatives to credit-builder loans

Like all credit products, credit-builder loans have both benefits and drawbacks. Whether you’re trying to build up a non-existent credit history or recover from a 500 credit score, these loans can help — but they aren’t necessarily the right fit for everyone.

If you’re looking to build credit but aren’t sure whether a credit-builder loan will meet your needs, here are some alternatives to consider:

• Secured personal loan — These loans offer upfront disbursement of funds, but you’ll provide an asset as collateral to secure the debt, such as your car title or home equity. This collateral reduces the lender’s risk and may make it easier for low- or no-credit borrowers to qualify. But if you fall behind on your loan payments, the lender can take your collateral.
• Secured credit card — These lower-limit credit cards allow you to build your credit history. You’ll pay a deposit to get the card, and your credit limit is generally the same as your deposit amount. But if you make on-time payments for a certain period of time, you may be able to convert your secured card account into a traditional credit card product.
• Become an authorized user on a credit card — A parent, spouse, sibling, or friend with good credit can add you to their existing credit card account as an authorized user. In many cases, their own account activity will then be reported to your credit, helping you establish or repair your credit score without having to spend money.