Credit Builder Loans Explained
A credit builder loan helps those with poor credit scores or limited credit history to demonstrate creditworthiness. Borrowers agree to fixed monthly payments, which helps build up their score, as long as they repay the loan in full.
If you have a poor credit score, or not much credit history, also known as a “thin” credit file, it can be challenging to take out a loan. Many lenders will not accept applications from those with poor credit scores or limited credit histories because they are seen to be a greater risk than someone with a good credit score. That perceived risk is mainly because there isn’t a history or evidence of repaying loans on time.
This can leave you in a chicken and egg situation — you need a better credit score to borrow, but your credit score won’t improve unless you borrow money. Lenders like to see that you can handle credit well and have repaid loans regularly and promptly.
This is where credit-building loans come in.
» MORE: How to check your credit score
What is a credit builder loan?
Credit builder, or credit repair, loans are specifically designed to help those with bad credit scores or a limited credit history improve their scores. By making all the repayments on a credit builder loan, you demonstrate that you can manage your finances and repay a loan in full.
These loans aim to help you rebuild your credit score, so if you need to borrow money in the future, you can hopefully access more affordable rates.
Credit builder loans typically only offer a relatively small sum of money. The amount you can borrow varies between providers, but it can range from around £500 to £5,000 over a period of 12 months or more.
Mainstream banks and lenders don’t typically offer these kinds of specialised loans but online providers and credit unions do. However, you may not always be eligible for a loan from these organisations.
How do credit builder loans work?
Credit builder loans may operate differently from conventional personal loans.
When you apply for a credit builder loan, you agree to borrow a set sum of money and repay it in monthly instalments. However, you may not always be able to access the money straight away. In these cases, you would send the lender agreed monthly repayments and the money is released to you at the end of the term.
Not every credit builder loan works in this way, so check with the individual provider.
If you opt for a credit builder loan it’s vital to make sure that you can realistically afford it. Providers will conduct credit checks and check your income and employment status to make sure you can afford the repayments.
As with any other loan, if you miss a payment the lender can report this to the credit reference agencies which would further damage your score, undermining your efforts for improvement.
Who are credit builder loans for?
Credit builder loans are intended for people with bad credit scores or limited credit histories, such as young people who haven’t had time to build up a credit history.
These people may struggle to get accepted for a loan elsewhere or, if they are accepted, they may face high interest rates. Credit builder loans can help these individuals to improve their credit score and increase their chances of accessing credit in the future.
However, not everyone will qualify for credit builder loans. Providers set their own criteria, so you may only be able to get a credit builder loan if you’re a certain age, live in a certain area, or have a minimum income, for example.
In some cases, you may not be able to apply for a credit builder loan directly. Instead, a provider may direct you to their credit builder loan if you don’t qualify for their standard loan.
If you can’t find a credit builder loan that you are eligible for, there are other ways you can rebuild your credit history.
Pros and cons of credit builder loans
Credit builder loans have several advantages including:
- Each month’s repayment is reported to credit reference agencies.
- Your credit score will improve if you pay each instalment on time.
- You will receive a sum of money that you can use as you wish (depending on the loan agreement of the provider, you may get this at the end of the term).
- Paying off the loan should improve your chances of accessing credit at more affordable rates in the future, rather than needing to take out high-cost credit from sub-prime lenders.
However, credit builder loans also have some disadvantages:
- You can only borrow a relatively small sum of money.
- In some cases, you will only receive the money once you have made all your repayments.
- They are only available from certain credit unions and other providers.
- Providers will set their own criteria, so you may not be eligible.
- They can be an expensive way to rebuild your credit score.
While credit builder loans have their uses, they may not be available or suitable for everyone.
If you need money and don’t have time to build up your credit, there are options if you want to borrow with bad credit. However, bear in mind that these alternatives are likely to come with high interest rates and if you miss a payment, or your application is refused, this will harm your credit score.
» COMPARE: Loans for bad credit
Credit builder credit cards
Credit builder credit cards offer a way to improve your credit score by showing that you can clear your debts on time and can manage your finances. The credit limit on these cards will often be lower than on standard credit cards.
They may be preferable to a credit builder loan if you need to pay for something straight away, and they can end up being cheaper if you clear the balance in full each month. They are also more readily available than credit builder loans.
Other ways to improve your credit score
Credit builder loans can be a costly way to improve your credit score. There are several things you can do to boost your score for free, so it’s worth trying these before looking into a credit builder loan.
For example, you can make sure you are on the electoral register and that there are no mistakes on your credit file. If there are any mistakes, you should contact the credit reference agency to correct them.
You can also sign up for schemes that use information about your rent, bills, and other regular payments to calculate your credit score. So, if you make these payments on time, you show credit reference agencies and lenders that you can manage your finances, which could make lenders look more favourably on any applications you make.
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Laura is a journalist and author, writing about money since 2008. Including writing for The Times for 9 years. She believes finance doesn't need to be complicated. Author of Money: a user's guide. Read more
Rhiannon is a financial writer for NerdWallet, with a particular interest in personal finance and insurance guides for consumers. Read more