Credit builder loans: What are they?
Quick insights
- Credit builder loans are a type of loan designed to help consumers establish, rebuild or improve their credit.
- Credit unions, community banks and some online lenders are typically the financial institutions offering credit builder loans. Note: Chase doesn’t offer these loans.
- There are both pros and cons to credit builder loans, so it’s important to learn about them before deciding whether they could be right for your situation.
Credit builder loans are a specialized financial product designed to help individuals establish or improve their credit history. These loans are typically offered by credit unions, community banks and some online lenders. Note: Chase doesn’t offer these loans.
What else is there to know about credit builder loans, and how do they fit into the broader credit improvement landscape? Read on to find out.
How credit builder loans work
Unlike traditional loans, the borrowed amount of a credit builder loan is held in an account while the borrower makes monthly payments, which are reported to the credit bureaus. Once the loan is fully repaid, the borrower receives the funds.
Credit builder loans may be appealing to people with no credit or poor credit who want to build a more positive credit profile.
An overview of the credit builder loan process might look something like this, if the potential lender decides to approve the credit builder loan application:
- The lender approves the loan. But instead of giving the money upfront, it is placed in a locked savings account or certificate of deposit.
- The borrower makes fixed monthly payments over a set term, usually 6 to 24 months.
- Each payment is reported to the three major credit bureaus—Experian™, Equifax® and TransUnion®—helping the consumer build or improve their credit history. Please note that missed payments will also be reported.
- After all payments are made, the borrower receives the loan amount, plus any interest earned, if applicable.
No upfront access to funds means less risk for the lender while still offering a credit product that can benefit both sides. The lender may earn some interest and the borrower gets a chance to show responsible payment behavior.
To make them more accessible to consumers, many lenders offer credit builder loans with low interest rates and flexible terms.
Positives of credit builder loans
There can be both pros and cons to credit builder loans. Let’s dive into the potential positives:
- Providing a safer and structured way to build or rebuild credit, especially for those with limited or poor credit history.
- On-time payments may help improve your credit score over time, improving your chances to qualify for other financial products.
- The process overall tends to encourage financial discipline and regular saving habits.
- Some credit builder loans offer interest on the locked funds, providing a small financial benefit at the end of the term.
- They are generally easy to qualify for, even if you have no credit or a low credit score.
- Many lenders report to all three major credit bureaus, maximizing the potential impact on your credit profile.
Potential risks and downsides of credit builder loans
Now that we covered the potential positives, let’s look at some possible risks or negatives to credit builder loans:
- Missing payments can hurt your credit score, since negative payment history is reported to the credit bureaus.
- Some credit builder loans come with fees, such as application fees, monthly service charges or early withdrawal penalties.
- Funds can’t be accessed until the loan is fully repaid, which may not be convenient if you happen to need the money.
- Interest rates and fees can vary widely between lenders, so it helps to compare options before applying.
- Not all lenders report to all three credit bureaus, which can limit the effectiveness of the loan for credit building.
- If you already have good credit, a credit builder loan may not have many, if any, additional benefits.
Who should consider a credit builder loan?
While anyone can apply for a credit builder loan, the ideal candidates might include:
- Individuals with no credit history, who want to build a credit profile.
- Consumers with poor credit and want to rebuild their credit.
- Those who want to establish a positive payment history before applying for other loans or credit cards.
- Consumers who want a structured, disciplined approach to saving and credit building.
- Those who are unable to qualify for traditional loans or credit cards due to their credit status.
Tips for choosing and using a credit builder loan
To find the best credit builder loan for your needs, it can be helpful to compare lenders for interest rates, fees and reporting practices. Ask and find out whether the lender reports payments to all three major credit bureaus. If they don’t, you might consider finding a different lender that reports to all three major bureaus.
It can help to set up automatic payments to avoid missed payments and the resulting negative impacts to your credit.
Before signing on the dotted line, read the loan agreement carefully to understand all terms, fees and conditions.
Think about using the loan as an opportunity to build strong financial habits, such as budgeting, saving and spending responsibly. Lastly, monitor your credit score regularly to track your progress and ensure payments are being reported correctly. You can do this with the help of a free credit monitoring tool like Chase Credit Journey®.
Conclusion
Credit builder loans can be a valuable tool to help improve your credit score and establishing a positive credit history. They can offer a structured way to save money—but it’s important to understand the risks and potential downsides, too.
Consider your financial goals, current credit status and ability to make regular payments before applying. And be sure to read the terms and conditions before agreeing to anything.
When trying to find the right option for you, research lenders and compare options to maximize the benefits and minimize potential downsides. With responsible use, a credit builder loan can help improve your credit profile and consequently open doors to more financial opportunities in the future.
