Having a good credit score is a financial game-changer. Good credit helps you qualify for much-needed loans (like student loans, auto loans, and home loans) and can help you earn a lower interest rate on those loans, reducing the amount you have to pay to borrow money. Your credit score can also affect your ability to get an apartment or even certain jobs.
But how do you build good credit?
A traditional option is often to sign up for credit cards to establish a credit history. However, considering that easy access to credit cards can also often result in overspending and future financial struggles, more and more people are curious about how to build credit without a credit card.
Credit builder loans are a strong option for improving credit scores without using credit cards. Learn more about what a credit builder loan is, how it works, and how it can help you build good credit.
What is a credit builder loan?
A credit builder loan is a special type of loan specifically designed to help borrowers build credit from scratch or repair damaged credit.
Credit builder loans1 do not work like standard loans. With a standard loan, you borrow a set amount of money, spend it, and then repay the loan over time with interest. With a credit builder loan, your lender places a set amount of money in a special savings account for you, but you can't access the funds2 until you have repaid the loan with interest through monthly installment payments.
This arrangement allows lenders to loan you money with very little risk3. If you fail to repay the loan, they simply don’t give you access to the funds. Since the risk level is so low for the lender, they can also offer you a comparatively low interest rate, empowering you to build or improve your credit without paying excessive interest.
You might think about credit builder loans as a form of savings. You pay in every month and get to access your savings (minus the interest) at the end of the loan term.
Do credit builder loans really help improve credit scores?
As long as you make payments on time, credit builder loans can help improve your credit score by:
- Establishing a solid payment history: Your lender will report each payment toward your credit builder loan to the three credit report bureaus (Equifax, Experion, and TransUnion). This is a big deal because payment history accounts for 35% of your FICO credit score.4
- Increasing the length of history over time: Having long-standing accounts boosts your credit score, while brand-new accounts can bring it down. So you might see a small dip in your score any time you open a new credit line (including your credit builder loan), but as these accounts age over time, they can bring your score up.5
- Altering your credit mix: Your credit mix includes the different types of loans you have, such as revolving credit card lines, installment loans, and mortgages. You don’t need to collect one of every kind, but having some diversity in your credit mix is beneficial. As an installment loan, a credit builder loan can diversify a credit-card-heavy profile.6
However, if you don't make your payments on time, credit builder loans can actually hurt your credit. This is because the lender would report late or missed payments to the credit reporting bureaus, which takes points off7 your credit score. Late payments appear on your credit report after 30 days and remain there for seven years.
How much can a credit builder loan increase my credit score?
According to a report by the Consumer Financial Protection Bureau (CFPB), credit builder loan participants without other existing debts saw credit score increases of 60 points relative to their peers with debt over a 12-month period.
Keep in mind that accepting a credit builder loan is only beneficial if you can commit to making your payments on time every month.
How to choose a credit builder loan
When looking for a credit builder loan, consider these factors:
- Interest rates and fees: Look for competitive rates, typically ranging from 5% to 16% APR8
- Loan amounts: Most loans range from $300 to $1,000
- Reporting to credit bureaus: Ensure the lender reports to all three major credit bureaus
- Where to find them: Credit builder loans are typically offered by credit unions, community banks, and some online lenders
Popular credit builder loan products
Are you ready to try a credit builder loan to increase your credit score? Here are some of the best credit builder loans available:
Self
Self offers 24-month credit builder loans of $600 to $3,600. After making at least $100 in payments, you can get a secured credit card to access amounts already paid into the credit builder loan.
Interest rates are comparatively high, ranging between 15.51% and 15.92%, depending on your chosen plan. For example, if you pay $25 per month into the credit builder loan at 15.92% interest, you would get back $511 of your total $600 investment at the end of the 24 months.
Credit Karma
Credit Karma offers a no-cost credit building program, but it works differently than traditional credit builder loans. You need a TransUnion credit score of 619 or below to qualify and must establish a Credit Karma Money™ Spend account.
The program provides you with a line of credit that you use to transfer money to a locked savings account. You choose how much to save each pay period (minimum $10), then immediately repay that amount. Your payments are reported to all three credit bureaus. Every time you save $500 total, that amount is transferred to your accessible Credit Karma Money Spend account.
Kikoff
Kikoff provides a suite of credit-building products, charging transparent flat fees of $5 to $35 (depending on your chosen program) instead of interest rates.
Credit builder loans are offered as add-ons to Kikoff's comprehensive credit-building programs. As an add-on service, there is no extra charge for this loan. You can get a $120 credit builder loan, paying $10 per month over 12 months, and access the full $120 at the end of the year.
This loan is reported to TransUnion and Equifax but not to Experian.
Kikoff claims that users with a starting credit score below 600 see significant credit score improvements, though specific average increases may vary by individual circumstances.
Pros and cons of credit builder loans
Credit builder loans offer the following benefits9:
- Can build credit fast. On-time payments are reported to the credit bureaus, boosting your score month after month.
- Encourages savings. The loan amount is typically held in a savings account until fully repaid, helping you build a financial cushion over time.
- Might not require a credit check. Since the risk is low for lenders, they might not need to run your credit to approve the loan.
However, credit builder loans also come with some limitations and potential drawbacks, including:
- Limited access to funds. Unlike secured credit cards10, which provide immediate access to your funds, credit builder loans lock your funds in savings until you finish repayment or reach a set savings milestone. Therefore, you may not be able to access your funds for the duration of the loan program.
- Monthly payment commitment. Applying for a credit builder loan establishes a financial obligation to make on-time payments for the term of the loan.
- Risk of a decrease in credit score. Missing payments or even making payments late can hurt your credit score, defeating the purpose of the loan.
- Interest and fees. Some lenders charge interest or administrative fees, costing you additional money over the term of the loan.
- Limited credit utilization improvement. Unlike revolving credit cards, installment loans typically don’t help your credit utilization ratio(the amount of debt you carry as a percentage of your available credit limit). Credit utilization accounts for 30% of your FICO score, which is why many people choose to maintain long-term credit lines, either paying the balance in full every month or keeping the balance below 30% of the credit limit.
7 Tips for maximizing the benefits of a credit builder loan
Take the following steps to make the most of your credit builder loan:
- Shop around for low fees/interest rates. Lower fees and interest rates allow you to keep more of your money.
- Choose a loan with an affordable payment amount. Make sure you can comfortably afford the monthly payment to reduce the risk of missed payments.
- Set up auto-pay. With auto-pay, you can automatically transfer the money from your bank to your lender, reducing the risk of late payments or missed payments caused by simply forgetting to make the payment manually.
- Avoid early payoff. Paying off the loan early would prevent the lender from reporting more on-time payments to the credit bureaus, which would stop your credit score progress. Focus on consistent payments over time.
- Keep up with your other bills. A credit builder loan will not improve your credit score if it causes you to fall behind on other financial obligations. Make sure you can pay all your bills on time every month.
- Have a plan for your savings. After working so hard to save this money, make sure it’s put to good use. You might use it as the beginning of your emergency fund, for example. Or use it as a deposit for a new apartment.
- Monitor your progress. Americans are entitled to free annual credit reports. This allows you to track your progress as you work on improving your credit score.
Start building good credit today
Like secured credit cards, credit builder loans can improve credit scores without inviting the temptation to overspend on traditional credit cards. By making consistent on-time payments, choosing the right loan terms, and managing your finances wisely, you can use a credit builder loan to set yourself up for better financial opportunities in the future.
*Sources for this article can be found below.
