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A credit-builder loan can help people who have little or no credit history build credit. They go by other names like "Fresh Start Loans" or "Starting Over Loans" because they're designed for those just starting or rebuilding their credit histories.
Growing your score has many benefits, like making it more likely you’ll be approved for credit cards and loans, or get a better rate.
Credit-builder loans are typically offered by smaller banks and credit unions, but you may also find online lenders that offer them. Most loans are $500 to $3,000 with a term of six to 24 months. Annual percentage rates and fees vary.
Credit-builder loans do not require good credit for approval, but you must have enough income to make payments. When applying, you may need to provide details about your employment history, income and balance in your checking or savings account.
» COMPARE: Best personal loans for bad credit
How does a credit-builder loan work?
A credit-builder loan operates like a traditional loan in reverse. With a traditional loan, you receive the money first and pay it back over time. With a credit-builder loan, the lender keeps the loan amount while you make payments. Once you’ve made all the payments, you receive the full loan amount.
Holding the money in a secured account until the loan is fully repaid acts as a safety net for the lender that’s taking on risk if you have no experience with credit or low credit scores.
Your on-time payments toward a credit-builder loan are reported to at least one major credit bureau, but look for loans that report to all three (Equifax, Experian and TransUnion) if possible.
Credit scoring models FICO and VantageScore weigh your payment history above all other factors when compiling scores, so having on-time payments reported helps build your credit and shows you can handle a credit account.
Another benefit of a credit-builder loan? At the end of the loan's term, you'll have money you can put toward an emergency fund or another important savings goal.
Who can benefit from a credit-builder loan?
There are two situations where you might want to consider a credit-builder loan:
You don’t have a credit score
Credit-builder loans can help you establish credit if you’re "credit invisible" — meaning you don't have a credit score or report.
Some 28 million Americans fall into this category, according to a 2022 report by Experian and management consulting firm Oliver Wyman. The same report found that another 21 million Americans are considered “unscorable” because their limited credit file doesn’t have enough information to produce a credit score.
While you can use debit cards or cash if you have little or no credit history, not having a credit score can pose real obstacles. With no credit score, it can be difficult to purchase a car or home, get approved for a credit card or sign an apartment lease.
You have bad credit
If you have bad credit due to missed payments, a credit-builder loan could help you establish a positive history. It won’t erase past late or missed payments, but the impact of those negative marks tends to fade over time. If you’re also making on-time payments on a credit-builder loan, you’ll see your score gradually improve.
🤓 Nerdy Tip
While it’s not the most important factor, credit mix is used to determine credit scores. Having a credit history with different kinds of accounts (for example, credit cards and an installment loan) can build your scores. When a credit-builder loan may not make sense
A credit-builder loan may not make sense if:
- You're already on the credit radar: If you've taken out a loan or opened another credit account, you're less likely to see much benefit from a credit-builder loan compared to those who have no credit profile.
- You need access to the loan amount quickly. Six months is typically the fastest you’ll be able to get the full loan amount after making on-time payments.
- You’re struggling to pay bills. If you’re having trouble paying for necessities, adding another monthly payment to the mix isn’t a good idea. Focus on covering your needs first. You can consider a credit-builder loan later, once your finances have stabilized.
Where to find credit-builder loans
Credit-builder loans are not widely advertised and are generally offered by smaller financial institutions.
Credit unions: Many credit unions offer credit-builder loans, but you’ll need to be a member to apply for one. In general, credit unions tend to be a good option for getting a loan with bad credit because they consider your membership history in addition to your credit file.
Community banks: Smaller, locally-owned banks are more likely to offer credit-builder loans than major financial institutions.
CDFIs: Explore the offerings of a Community Development Financial Institution, which often provide credit-building products. These organizations exist to help lower-income communities. There are about 1,400 CDFIs in the U.S.
Online lenders: Some online lenders offer credit-builder loans, but not all lenders are licensed in every state. Loan payments, terms and APRs vary widely.
How to choose and manage a credit-builder loan
- Research and compare lenders. Look for a credit-builder loan with a payment and term you can comfortably handle. Stretching your budget will only increase your risk of missing a payment and damaging your scores. Choose a loan that reports payments to all three major credit bureaus, if possible.
- Make payments on time. If you pay the loan as agreed, you build good data on your credit reports. But a payment more than 30 days late will also go on your reports and can seriously hurt your scores.
- Monitor your credit score. Use a personal finance website like NerdWallet to get a free credit score. NerdWallet updates your score weekly; watch the overall trend of your score, but don’t obsess over tiny changes.
- Decide what to do with your loan proceeds, plus any interest. At the end of the loan term, you get the money — and likely a better credit score. If possible, use that money as an emergency fund. Having a few hundred dollars saved can insulate you from unexpected expenses that otherwise might lead to debt or missed payments and score damage.
Alternatives to credit-builder loans
- Secured credit cards: With a secured credit card, you put down a deposit that’s usually equal to your line of credit. Because the deposit is your collateral, it’s easier to qualify for a secured credit card than a regular credit card. Deposits are refundable and typically start at $200. You can also explore alternative credit card products that do not require a deposit.
- Secured loan. If you have money in the bank, you may have another option for an installment loan: a share- or certificate-backed loan. The funds you already have at the financial institution is the collateral, and that money is frozen until the loan is repaid.
- Become an authorized user: If it's an option, you could also ask a friend or relative who has excellent credit to add you as an authorized user on a credit card. As an authorized user, that card's account history will be added to your credit report. The primary user doesn't have to actually give you the card, and you don't need to make charges — just being associated with their stellar credit reputation helps yours.
- Lending circle. Another credit-building plan is participating in a lending circle where participants get interest-free "social" loans and payments are reported to the credit bureaus. The nonprofit Mission Asset Fund runs a lending circle program, and other organizations also offer versions of this practice.
Frequently Asked Questions
Is a credit-builder loan good for my situation?
Credit-builder loans can be a strategy for boosting credit and savings, especially if you don’t have much credit or have a poor credit score. They may be a good idea if you have the income to make regular, on-time payments. Be wary of interest and fees that create added costs, and understand you’ll put your credit at risk if you miss a payment.
Should you use a personal loan to build credit?
A personal loan can help you build credit if you make on-time payments and build a good payment history. If you use the loan for debt consolidation, it may also improve your credit score by lowering your overall credit usage.
If your credit is damaged or thin, you’ll pay higher interest rates. Avoid lenders that charge APRs above 36%, which tends to be the ceiling for most personal loan lenders that check credit. Also, make sure the lender reports payments to the credit bureaus.
What are the requirements to get a credit-builder loan?
To get a credit-builder loan, you’ll need to show proof of sufficient income. Some lenders will also look at your bank account history for things like bounced checks. However, since credit-builder loans are meant for people with bad credit or limited credit histories, they’re typically easier to get than other types of credit.
What are the potential downsides to a credit-builder loan?
Credit-builder loans may come with upfront fees in addition to the interest you’ll pay on the loan. The time it takes to receive the funds can also be a significant downside if you need to borrow money fast.
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