How Do Credit Builders Work?
For those looking to establish or rebuild their credit history, credit builder loans can be a useful tool. These specialized loan products are designed specifically to help build credit by reporting your payment history to the major credit bureaus. Here's a detailed look at how credit builder loans work and what to expect.
What is a Credit Builder Loan?
A credit builder loan is a type of installment loan where the borrowed money is held by the lender in an account while you make payments. The lender reports your monthly payment history to the credit bureaus, which allows you to build a positive credit history over the loan term, typically 6-24 months.
How It Works When you open a credit builder loan, you are approved for a small loan amount, often between $300-$1,000. However, the full loan amount is put into a locked savings account or certificate of deposit (CD) by the lender. You cannot access this money upfront.
You then make monthly payments over a set term, just like a regular loan. This payment history is reported to the major credit bureaus (Experian, Equifax and TransUnion) each month. As long as you make on-time payments, this builds your credit history and credit score.
After you've completed all payments, you receive the full loan amount plus any interest earned on the account during the loan term. This creates a forced savings component in addition to building your credit.
Loan Terms and Fees
Credit builder loan terms typically range from 6-24 months, with 12 months being very common. The loan amounts are relatively small, from $300 up to around $1,000.
There is usually an administrative fee or other upfront cost to open the loan, often $20-$100. The interest rates can vary widely between around 5-20% APR.
Since the money sits in an account untouched, there is no risk to the lender of default. This makes credit builder loans accessible to those with poor or no credit history.
Where to Get One
Many credit unions, community banks and nonprofit organizations offer credit builder loan programs. Some of the major national options include:
- Chime
- Self
- Extra
Online lenders and fintech companies have made these products more widely available in recent years. There are also secured credit card options that can serve a similar credit building purpose.
Pros and Cons
Like any financial product, credit builder loans have potential pros and cons to weigh:
Pros:
- Builds credit payment history from scratch
- No hard credit check required
- Funds are secured and returned after completion
- Lower fees than other loan options
Cons:
- Money is locked up and inaccessible
- Limited loan amounts
- Need to make on-time payments
- Upfront administrative fees
Who Can Benefit
Credit builder loans can be a good fit for various situations, including:
- Those with little/no existing credit history (students, immigrants, etc.)
- People recovering from bankruptcy or defaults
- Building credit after past mistakes or errors
- Adding an installment loan to your credit mix
The key is making full on-time monthly payments during the loan term. This positive payment history is what gets reported and helps build your credit score over time.
While credit builder loans have some fees involved, they provide an avenue to proactively build credit history in a structured, lower-risk way. For those struggling to get approved for standard loans and credit cards, they offer a path to establish credit and access more affordable borrowing options down the road.
The information is provided for educational and informational purposes only. Such information or materials do not constitute and are not intended to provide legal, accounting, or tax advice and should not be relied on in that respect. We suggest that You consult an attorney, accountant, and/or financial advisor to answer any financial or legal questions.
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