What is a Credit Builder Loan and Should You Get One?

If you have a low credit score or no credit history, it can be difficult to be approved for a loan or a mortgage. But there are several options for building credit and improving your credit score.

Credit builder loans, also known as fresh start loans and starting over loans, can help you establish that you’re a responsible borrower. A credit builder loan is a small, secured loan — usually between $500 and $5,000. Unlike a regular loan, you pay a credit builder loan back before you receive the money. The loan is a line of credit, and the payments appear on your credit report, helping to prove your creditworthiness and credit score.

How Does a Credit Builder Loan Work?

You can apply for a credit builder loan with a bank, credit union, or online lender. Typically they’re offered by smaller institutions rather than larger banks and institutions. If you’re accepted, the money is held in a bank account or a certificate of deposit while you make regular payments over 6–24 months. Once you’ve made the required payments, you’ll receive the money. Depending on the provider, the interest you paid might be reduced or refunded to you.

Here’s an example. An online lender offers a credit builder loan for $525. There’s a fee of $10 to activate the account. The payments are $25 per month for 24 months, with an APR of 15.92 percent. The amount you receive after making payments is $525. The total amount spent is $618.58, making the cost of the loan $93.58.

You don't need a perfect credit score to apply for a credit builder loan. In fact, your credit score won’t be checked at all. Instead, you'll be assessed based on your income and bank statements. As long as you're 18 years or older and a U.S. citizen with a social security number, you’re eligible.

Lenders who offer credit builder loans report your payments to the main credit bureaus. According to the Credit Builders Alliance, loan repayments made on time for six months can help increase your credit score by 35 points. An individual with no previous credit history who makes timely payments for six months can end up with a solid credit score.

While regular loans and credit cards offered to those with low credit scores often have sky-high interest rates, credit builder loans can have rates as low as 3 percent. Plus, many lenders refund some or all of the interest once you’ve made all the payments.

How Can You Get a Credit Builder Loan?

If you think a credit builder loan could help boost your credit history, here’s how to get one.

Find a lender: Big banks don’t usually offer small credit-building loans. Instead, you’re likely to find them through local credit unions, community banks, and online startups. To maximize the positive impact on your credit score, make sure that your repayments will be reported to all three credit bureaus: Experian, Equifax, and TransUnion.

Compare rates: Interest rates vary widely with credit builder loans — from as low as 3 percent to more than 19 percent APR and sometimes even more. Shop around for the lowest rate and check whether the interest is reimbursed once you repay the loan. Some companies also charge an initial set-up fee, while others don’t. You should check to see if there are late fees if you miss a payment.

Decide how much to borrow: Making payments on-time is the goal. Make sure you don’t borrow more than you can afford, otherwise it could cause a negative mark on your credit history.

Apply for the loan: You won’t need a credit score or even a credit history to apply. But you do need some financial stability. You’ll need to supply details about your employment and income, any other loans you have, along with your bank account balances. You also need to be 18 or older, a U.S. citizen, and have a social security number.

Other Options for Rebuilding Credit

Besides credit builder loans, here are other options for establishing good credit.

Become an authorized user: Do you have a friend or family member who will add you to their credit card? As an authorized user, payments show up on your credit report — as long as the credit card issuer reports activity to the credit bureaus.

Apply for a secured credit card: Secured credit cards are often granted to those with a minimal credit history or a low credit score. With a secured credit card, you’ll make a deposit upfront which acts as collateral in case you fail to make repayments. By making on-time payments with a secured card, you can often transition to a regular unsecured credit card with the same company.

Take out a secured personal loan: Personal loans can help you build a positive credit history. You’ll need to list collateral — such as a vehicle — in case you default on the loan. Be sure to review the interest rates and repayment requirements before taking out a personal loan, as they can be expensive.

Building credit is a worthwhile activity. Good credit makes a difference in the kind of lifestyle you can lead, from what car you can lease to what house you can buy. A credit builder loan can be a stepping stone to excellent credit. Just be sure to review the repayment schedule and interest rates before you agree to the terms.