Credit-builder loans are specifically designed to help borrowers with a negative, limited, or nonexistent credit history to build their credit. When you take out a credit-builder loan, the payments you make help you create a history of on-time payments. Unlike traditional loans, you don’t get the money from the loan itself until you’re done paying it off.

How does a credit-builder loan work?

With a credit-builder loan, you typically don’t get the money until after you make all of the payments. Instead, the lender will put the funds in a locked savings account, and they’re disbursed after you’ve made the final payment. Depending on the lender, they’ll deposit the money in your account after each payment, or they’ll wait until you’ve paid in full. The terms for credit-builder loans are usually between six and 24 months. 

This differs substantially from a traditional loan, where you generally have the full amount disbursed to you before you make any payments. Credit-builder loans are less risky for lenders since they hold on to the funds until the borrower makes all their payments. For a borrower, a credit-builder loan offers an opportunity to create or boost their credit score — and when the loan is fully paid off, they end up with a nice savings balance.

Another way that credit-builder loans differ from traditional loans is that by their very nature, you can qualify with a low credit score or no credit score. However, lenders will still look at your employment, your income, and your banking history, as well as your other debts, to determine whether you’re capable of making the payments.

How long does it take to see improvements in my credit score?

How much and how quickly a credit-builder loan improves your credit score will depend on a variety of factors, including if you make your payments on time, whether you already have a credit score or not, and other elements of your financial picture. 

Where to get a credit-builder loan

A variety of lenders offer credit-builder loans, but some of the most common places to find these financial products are community banks, credit unions, and online lenders. When looking for a credit-builder loan, keep these things in mind:

• Monthly payments: Ensure that you’re making your payments on time each month. Otherwise, missing any payments defeats the purpose of taking out a credit-builder loan.
• Total loan cost: Over the life of the loan, you’ll pay interest and any fees the lender charges. Read the fine print closely to ensure that there won’t be any surprises. Compare what the fees and interest rate will cost you over the life of the loan. For instance, given the loan terms mentioned above — a $600 loan with a 15% interest rate and a 12-month term with no additional fees — you can expect to pay roughly $50 in interest over the life of the loan.
• Disbursement timeline: Since the funds from a credit-builder loan aren’t disbursed in the same way as traditional loans (in a lump sum upfront), consider the time frame in which the lender will make those funds available to you. Generally, the two options are either making the principal available after each month’s payment or making the full loan amount (minus interest and fees) after the loan has been successfully repaid.
• Benefits and features: Are you looking for a lender that will offer credit counseling as well as a credit-builder loan? Do you want to automate payments? Take a look at what’s available and pick a lender with the bells and whistles you want.
• Lender reputation: Make sure you’re choosing a reputable lender — predatory lenders may count on the fact that someone with a low or nonexistent credit score may be new to the financial world and try to scam you. Look at reviews online and keep an eye out for signs of a predatory lender, such as an exorbitant interest rate and hidden fees. 

Here are three lenders that offer credit-builder loans to give you a sense of the terms you might find on the market.

Pros and cons of credit-builder loans

A credit-builder loan can help you save money and boost your credit history, but here are some things to consider first:

Pros

• Can help you build credit: The most obvious benefit is also the main one: A credit-builder loan can help you build a history of on-time payments and either establish or boost your credit score. 
• Can help you build savings: A credit-builder loan can help you start a savings habit. If you pay one off successfully, you can end up not just with an improved credit score, but with a good start on an emergency fund.

Cons

• Can actually have a negative effect on your credit score: If you already have existing debt, adding more debt can jeopardize your ability to make timely payments, which will have a negative impact on your credit score. A 2020 study from the Consumer Financial Protection Bureau found that people with existing debt who took out credit-builder loans actually often saw a decrease in their credit score and frequently made more late payments on their other debt after taking out the credit-builder loan.

Overall, the study found that credit-builder loans are best for borrowers with no credit history or a very limited credit file, and for borrowers who don’t have any existing debt. Opening a credit-builder loan boosted credit scores by up to 60 points for those who didn’t already carry debt — an “economically meaningful change.” 

How to apply for a credit-builder loan

The process of getting a credit-builder loan is similar to getting any other personal loan. Here’s what you can expect:

• Check your credit score: Even though a low credit score won’t prevent you from getting a credit-builder loan, it’s still best to review your credit report and see if there are any errors you should correct before applying.
• Shop for credit-builder loans: Take a look at multiple lenders and compare their products. Look for low interest rates, no fees or minimal fees, a monthly payment you know you’ll be able to afford, and a lender with a good reputation.
• Apply for the loan: You can expect to provide your government ID, proof of employment and income, and your monthly mortgage or rent payment when filling out your application. Lenders will use this to confirm your identity and to gauge whether you’ll be able to afford your loan payments.
• Complete the paperwork and start making payments: Once you’re approved, read the fine print carefully before signing. Then automate your loan payments or otherwise make sure that you’re prepared to make your monthly payments on time.

How to manage a credit-builder loan

It’s clear that a successful outcome from a credit-builder loan depends on making your monthly payments on time and in full. One of the most commonly used credit scores, the FICO score, uses five different data points to determine your score — payment history makes up 35% of your score and is the most important factor. 

Here are a couple of tips to manage your credit-builder loan:

• Ensure you can afford the payment: The most impactful way you can make a credit-builder loan work for you is by ensuring you can afford the monthly payments before you ever take it out. Add up your total monthly income and then subtract all of your monthly bills and expenses — the remaining amount is what you might be able to put toward a loan payment. Be realistic about whether you can afford an additional bill, and make sure you’re leaving some cushion for surprise expenses.
• Set up autopay: If automated payments are an option, set that up. If not, use multiple methods to remind yourself of when your payment is due. Use a calendar app, an email reminder, or set reminders on your phone a few days before the payment is due and on the due date.

If you don’t make your payments on time, you can actually damage your credit history while losing money in interest and fees. Set yourself up for success before you sign on the dotted line.

Alternatives to credit-builder loans

A credit-builder loan is a good tool to create a positive payment history and boost your credit score, but it’s not the only way to do so. Here are some other options that can help:

• Personal loans (secured or unsecured): A personal loan may be difficult to get with a low or nonexistent credit score, but there are lenders that will work with you. A personal loan can be used for virtually any purpose, and unlike a credit-builder loan, you’ll get the full amount disbursed to you upfront. If you have difficulty qualifying for an unsecured personal loan, you might consider using something you own to “secure” the loan. Homes, cars, and other assets are commonly used to back personal loans, which means you could lose that asset if you default on the loan. 
• Secured credit cards: A secured credit card is a credit-building tool similar to a credit-builder loan. They’re usually secured by a cash deposit equal to the amount of credit available on the card. By keeping a low balance and paying your bill each month, you can build a positive payment history.
• Certificate-backed loans: This is another credit-building tool that operates much like a secured credit card. You provide a cash deposit or another asset, and the lender gives you a personal loan. The cash deposit generally earns interest, allowing you to basically break even while building your credit history.
• Become an authorized user: If you have someone who is willing to allow you to become an authorized user on their credit card, you can build credit that way. Most credit card companies will report on-time payments for authorized users to the credit bureaus, helping you boost your credit score and diversify your credit mix. But remember: If the primary account holder misses payments, that can negatively affect your credit score. And on the flip side, if you abuse that person’s credit card, you could permanently damage the relationship. 

FAQ

Can I get a credit-builder loan if I have bankruptcy on my record?

Yes, you can get a credit-builder loan after bankruptcy — these loans are designed to help people with negative or nonexistent credit histories build or boost their credit scores. Lenders will likely review your employment history and income to determine if you’re a good candidate for a credit-builder loan.

How long does it take to build credit with a credit-builder loan?

Credit takes time to build, and FICO, one of the most popular credit scoring systems, notes that you can expect it to take about six months after taking out the loan to get a score.

Are credit-builder loans available for small businesses?

There are credit-builder loans designed for small businesses. Make sure that the terms work for you.

Can I pay off a credit-builder loan early without any penalties?

You’ll need to review the terms of the loan to ensure there are no fees or other penalties involved with paying off your credit-builder loan early, but there are other downsides. The purpose of a credit-builder loan is for you to establish a history of on-time payments, and paying off the loan ahead of time will defeat that purpose.