Should You Get a Credit Builder Loan?
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Do you plan on buying a house or car in the future? Would you like to lower your monthly utility bills and get lower interest rates if you need to take out a personal loan? A high credit score creates those possibilities for millions of consumers, but only some have good credit. People with bad credit scores can lose out on opportunities and need more financing to buy the right home in the right neighborhood.
If you want to repair your credit or establish credit history and get a score for the first time, credit builder loans can help. While you won’t find people with good or great credit scores taking out these loans, they can jumpstart your path to good credit. A credit builder loan can be a great financial product for building credit, but you should know the pros and cons before getting started.
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How do credit builder loans work?
A credit builder loan is a small, short-term loan, usually with a 6-24 month term. You can get this loan at a local bank or credit union, but online lenders provide more options. Regardless of where you get your loan, most lenders let you borrow up to $1,000 through this secured loan. The loan’s objective is to build a payment history. The lender will report your on-time payments to the major credit bureaus — Experian, Equifax, and TransUnion — supervised by the Consumer Financial Protection Bureau.
Since these are secured loans, they carry less risk for the lender. If you want a $1,000 loan, you must put up $1,000 before the loan begins. After you repay the loan, you get access to the original $1,,000 you put into it. This arrangement allows lenders to skip hard credit checks. Using one of these loans to build your credit is possible even if you need a better score. Persona loans accomplish the same objective since those lenders report your payment activity to the major credit bureaus. Still, not everyone can qualify for a personal loan due to their credit scores and debt-to-income ratios.
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The advantages of a credit builder loan
Credit builder loans have several advantages for consumers. Here are some strengths that make this loan an attractive choice.
- Repair your credit. Most people use credit builder loans to repair their credit scores. Your payment history gets reported to the credit bureaus, and since payment history makes up 35% of your score, your credit will improve.
- It’s easier to get one of these loans. Don’t have the best credit score or debt-to-income ratio? No problem. You can still get a credit builder loan.
- Reasonable monthly payments. Credit builder loans have low principal amounts at 6-24 month windows. You can get a loan that requires less than $100/mo to keep up with payments.
- Establish credit for the first time. Millions of Americans are credit invisible. That means they have no loan or line of credit to their name. Even if you are good with money, not having any credit history will hurt your application for a traditional loan. A credit builder account can be your first step to establishing credit and demonstrating good financial habits to creditors.
- Get lower interest rates and better terms on future loans. Improving your credit score is a big deal, especially when it’s time to get a mortgage or auto loan. Shaving a single percentage point on your mortgage rate can save you hundreds of dollars each month. A credit builder loan can move you in the right direction and save a lot of money in the long run.
The disadvantages of a credit builder loan
Every financial product has strengths and weaknesses. Some people can overlook the disadvantages and focus on the advantages of the resource instead. However, you shouldn’t ignore the cons of credit builder loans. You’ll better understand what you are getting into and if the loan makes sense for your financial needs.
- You have to come up with the loan amount. Want to get a $1,000 loan to access $1,000? Credit builder loans don’t work that way. Instead of receiving $1,000 from the lender, you must give them $1,000 to take out the loan. The lender puts this money into a savings account, and the borrower gets this capital back at the end of the loan term.
- You don’t receive capital right away. Most credit builder loan providers do not give you any capital until you repay the loan. In most cases, this defeats the purpose of taking out a loan, but since credit builder loans are for building credit, they make more sense for people with no credit history or individuals with bad credit. If you need a quick loan for an emergency expense, a credit builder loan is not the right choice. Some online lenders may give you a portion of your secured deposit back at the start of the loan, but these lenders are the exception rather than the rule.
- Credit builder loans can hurt your credit if you miss payments. Credit builder loans are not guaranteed to improve your credit score. If you make every on-time payment, your credit score will improve. However, your credit score will take a hit if you fall behind and make late payments. Make sure you can reliably make timely payments before taking out a credit builder loan. Review your existing debt to see how much you can handle and the effort repayment would take. You can opt for a longer loan term or lower principal to reduce the likelihood of falling behind on loan payments.
- High interest rates. Interest rates on credit builder loans vary, but the annual percentage rate (APR) for most loans is between 6% to 16%. The secured payment makes them less risky, but any loan without a hard credit inquiry usually has a higher interest rate. Most credit builder loans have lower interest rates than credit cards. You will have other fees, such as the administrative and application fees, in addition to the high interest rate.
Credit Saint takes action to fix unfair or inaccurate negative items harming your credit.
- 90-day money-back guarantee
- Free consultation
- 200k happy customers
- 19 years experience
- 11,000+ five-star reviews
Other ways to improve your credit score
A credit builder loan can be a great option for people who want to build credit, but it’s not the only financial product available. Borrowers with low credit scores can use other resources to build their credit, each with their own pros and cons.
Secured credit cards
These credit cards have lower credit score requirements, and some don’t even require hard checks on your credit report. Secured credit cards require a security deposit, just like credit builder loans. The security deposit becomes your credit limit. While these cards have higher interest rates than credit builder loans, you can use them like a regular credit card. You won't owe interest if you pay back the credit balance in full each month. Some credit card issuers even make it easy to switch to an unsecured card with rewards when you are ready.
Related: Best Credit Builder Credit Cards
Installment loans
These loans have monthly payments spread throughout the loan’s term. A credit builder loan is an installment loan, but some people can also qualify for a personal loan. You get funds to cover emergency expenses and don’t need a security deposit for these loans, but interest rates and loan terms vary depending on the lender and your credit score.
Lending circles: lending circles are more complicated, but they can work for some people. A group of borrowers join forces and contribute a small amount of money into a pool. One person can access this pool of funds at a time, so if you need emergency funds, this isn’t the best option. You will have to wait your turn. Everyone in the lending circle makes small monthly payments that all improve your credit score as long as you make them on time. It’s easier to keep up with monthly payments on large loan amounts since you are teaming up with others, but you don’t want to be the one who falls behind. Lending circles can create more friction than other financial products for people who fall behind on payments, especially if you formed that circle with family and friends.
Embarking on your credit-building journey
Consumers have many ways to build their credit scores after falling behind on previous payments or needing a credit history. Credit builder loans allow you to create positive payment history and help you qualify for better loans in the future. No matter where your credit score is right now, you can get it to a good level.
A higher credit score gives you access to more loans and better rates, but you don’t need as high of a score as you think. Conventional mortgages have a 620 credit score requirement, and you can even get an FHA loan with a 10% down payment if you only have a 500 credit score. Credit builder loans can give you momentum, but don’t stop there. Every little bit helps to strengthen your payment history and improve your credit.
Credit Saint takes action to fix unfair or inaccurate negative items harming your credit.
- 90-day money-back guarantee
- Free consultation
- 200k happy customers
- 19 years experience
- 11,000+ five-star reviews
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Writer
Marc Guberti is a business freelance writer who specializes in personal finance, digital marketing, and entrepreneurship. His award-winning book "Content Marketing Secrets" teaches readers how to create, promote and optimize content for growth and revenue. Marc also hosts the "Breakthrough Success Podcast," where listeners learn how to master content marketing and get more clients.
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