Credit-builder loans can help you build your credit score, and they don’t require good credit to start with.
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They’re not widely advertised and are generally offered by smaller financial institutions, such as credit unions and community banks. The purpose, as their name suggests, is to help people achieve credit respectability.
Financial institutions would like to see you succeed. After all, if you become a customer, you’re more likely to make money for them in the future. To make sure it doesn’t get burned on the loan, the lender will set strict limitations. Think of it as training wheels for credit.
Credit-builder loans go by many names, such as the catchy “Fresh Start Loans” or “Starting Over Loans.” If you’re looking to restore your credit with an installment loan, ask your bank or credit union about secured personal loans designed to help people who need to help build credit.
Secured credit cards have long been suggested as a means of credit building — and they can be very effective — but you first have to have enough money to pay the security deposit.
If you have an income but can’t pay a deposit for a secured credit card, credit-builder loans offer a way around that hurdle.
How credit-builder loans work
You apply for the loan, whether you have bad credit or no credit, and you are approved, but there’s a safety net for the lender. The money you borrow is deposited in a savings account — one that you cannot access until you have fully repaid the loan.
If you pay the loan as agreed, the financial institution promises to send a good report to the credit bureaus. A 2013 study showed an average improvement of 35 points with six months of on-time payments for loans as small as $100.
At the end of the loan term, you get the money — and likely a better credit score.
But be sure to pay on time. If you miss payments, that negative information would also be reported. The financial institution doesn’t take a big risk when it lends to you, because it can reclaim the money if you don’t hold up your end of the bargain.
If you’re looking for a credit builder loan and your credit union or community bank doesn’t offer them (or even know what they are), you might try a Community Development Financial Institution. These organizations exist to help lower-income communities, and there are about 1,000 of them in the United States. Government grants and other incentives make these small-dollar loans more attractive to financial institutions.
Online lenders include Self Lender, which offers $1,100 loans repaid over a year at $100 a month. At the end, you get $1,100 and a credit score with a year of on-time payments.
How secured installment loans work
You don’t have to be low-income to have crummy credit or a need to improve. If you have money in the bank, you may have another option for an installment loan: a share- or certificate-backed loan.
In that case, a deposit you already have at the financial institution is the collateral, and that money is frozen until the loan is repaid (or it may be incrementally thawed, as the loan is repaid). So if you have funds on deposit at a small bank or credit union, it may be worth asking if you can borrow against them to help re-establish your standing. Other lenders may allow you to borrow against the value of your car.
You may have other options for building credit
Secured loans such as credit-builder loans tend to be a good deal because the collateral reduces risk for the lender and greatly reduces the interest rate, which is typically well under 10%. The catch, of course, is that you don’t get the money until the loan is repaid.
If you are trying to build credit and need the proceeds of a loan immediately (for debt consolidation, for example), you will probably need to take an unsecured personal loan. That means the lender has no collateral, just the strength of your credit history, to rely on. If your credit is damaged or thin, you’ll pay higher interest rates, sometimes as much as 36%, which tends to be the ceiling with most lenders.
Some lenders who will grant you unsecured personal loans without checking your credit at all, but those installment loans are much more like payday loans. The lenders don’t check your credit, but they also don’t report to credit bureaus unless you default. And the loans carry interest rates that can easily reach 300% or higher.
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