Easy Guide to Credit-Builder Loans and How They Actually Help

Getting approval for a loan with a bad credit score is like applying for your first job. Employers don’t want to hire someone with no experience, but you can’t gain work experience if no one hires you. You might encounter the same roadblock when trying to apply for a loan or credit card with a low credit score: lenders and credit card companies want to see a higher credit score, but you can only boost your credit with a new loan or card.

A credit-builder loan (or credit-building loan) solves this problem. Here, we explain what a credit-builder loan is and how it can help boost your credit. We also explain standard fees, missed payments, and prepayments to help you decide if a credit-builder loan suits your needs.

What Is a Credit-Builder Loan?

Lenders offer small credit-builder loans, typically between $200 and $2,000, with repayment terms ranging from six to 24 months. With a traditional loan, the lender gives the funds to you upfront, and you pay it off over time. With a credit-builder loan, you make payments until you pay off the loan, then the lender releases the funds to you.

The lender holds the funds in an interest-earning certificate of deposit (CD) or a deposit account while you make payments with interest. Once you repay the credit-builder loan, you receive your money deposited directly into your checking or deposit account, often as a lump sum.

How Do Credit-Builder Loans Help Improve Credit Scores?

Borrowers consider credit-builder loans when they need help building credit for the first time or improving their overall credit health. Thirty-five percent of your FICO® credit score is based on payment history alone, so proving that you can make on-time payments goes a long way in building a positive credit history.

If you get a credit-builder loan, your lender may report your positive payment history., boosting your score and helping you qualify for traditional loans and credit cards if you consistently pay on time.

What Fees Do You Pay for Credit-Builder Loans?

Fees vary depending on where you go to get a credit-builder loan. Costs you may encounter include the following:

• Loan interest: You pay interest on credit builder loans just like traditional loans. Your annual percentage rate (APR) will depend on the lender, but APRs usually range between 6% and 16%.
• Administrative fees: Service and lender fees also vary. Always read loan contracts before signing to understand all involved costs.
• Late payment fees: Your lender may charge late fees for missed payments. You can also learn about these costs by carefully reading the loan contract.

When considering if you can afford the monthly payments on a credit-builder loan, remember to calculate fees to prevent taking a loan you can’t afford.

What Happens if You Miss a Payment?

Credit-builder loans only work to build credit if you make on-time payments consistently. Lenders will report late and missed payments, which can significantly drop your credit score, especially if you have little or no credit history.

You must pay on time to reap the potential benefits of a credit builder loan, which is why it’s essential to only borrow an amount you can afford to repay. Even a small $200 loan can help you improve your credit score if you make timely payments.

Tips for Making On-Time Payments

Remembering to pay a new loan on time can be challenging, so keep the following tips in mind:

• Only borrow what you can afford to repay.
• Use a calendar or daily planner to mark due dates.
• Set a payment reminder on your phone.
• Opt for payment reminders from your lender.
• Set up autopay if available.

If your payment due date falls on an inconvenient day, consider changing it. For example, you may request a new date if your current due date falls just before you get your paycheck.

Can You Pay Off a Credit-Builder Loan Early?

Lenders may charge penalties for paying off the credit builder loan early, and you must typically wait for your funds. We recommend not paying early, even if your lender allows prepayments with no fees. Credit builder loans work by developing a positive credit history, so paying early decreases the credit gains you could have earned.

For the best results, stick to the repayment schedule outlined by the loan term, and remember to make payments on time.

Can You Build Credit in Other Ways?

In addition to applying for a credit-builder loan, take a look at the following methods for boosting your credit score:

• Explore reporting opportunities: The more positive reporting on your credit report, the higher your score, so consider new reporting opportunities. For example, your landlord or property management company doesn’t have to report your rent payments. Still, they may do so if you ask them to.
• Get a secured credit card: Unlike traditional credit cards, secured credit cards require an upfront security deposit to cover the card’s available funds. Otherwise, it functions the same way. You can boost your credit score by making on-time minimum payments and keeping your card utilization below 30%.
• Become an authorized user: If you have someone you trust to make on-time payments, you may ask to become an authorized user on their credit card. As an authorized user, you can use the card to make purchases and gain positive credit history. However, your credit can suffer if the cardholder misses a payment, so examine your options carefully.

Building credit from scratch or overcoming a bad credit history takes time, but it’s possible. Consider a credit-builder loan or one of these other methods to help boost your credit.

Before the internet, consumers had to rely on credit unions and other small financial institutions for credit builder loans. Now you can apply online through Boost Your Score. We help consumers improve their credit with these unique loan products and secured credit cards. Apply for a credit-builder loan today, or call us at 1-800-259-1270 to learn more about your credit-building options.