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What is a Credit Builder Loan and How Does it Work?

Jenna Taubel

Jenna Taubel About The Author

Jan 10, 2023 5:45:00 AM

How do you build credit if you can't get approved for loan? One solution is a credit builder loan, it's a unique type of loan that helps you actively save money while building a credit score at the same time! There are many benefits to using a credit builder loan to improve your financial situation. 

How Does a Credit Builder Loan Work?

Credit builder loan explainedCredit building loans function the opposite way of a regular loan. With a typical loan you receive a lump sum of money upfront, and then you pay that money back over a specified period of time. With a credit builder loan you still pay installments over time, but those funds are then deposited into a savings account or certificate of deposit (CD) and held there for the duration of the loan, after the term is up, those funds are released to you. So instead of receiving that lump sum upfront, you received at the money at the end of the loan.

This helps you build credit because your payment history is reported to the credit bureau monthly just like with a typical loan. Also, like a typical loan there is an interest rate charged for the loan that is included as part of the payments. That being said, the funds that are placed into the savings account, also earns the interest at the designated rate for that account. Think of it is as a scheduled series of savings deposits that help improve your credit standing.

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Is a Credit Builder Loan a Good Idea?

Are credit builder loans worth itYes, credit builder loans are great options for building your credit! A credit builder loan can also help you establish good money behaviors, such as making on-time payment and saving for a goal. Learning these important financial skills can prepare you for more easily accessing other financial products, such as credit cards or personal loans in the future. 

A credit builder loan is a good idea for you, if you're: 

  • Someone with no or a very low credit score
  • Someone who cannot qualify for other credit products
  • Someone who wants to build their savings

Additionally, credit builder loans are a good idea for you if you do not have other outstanding debt on your credit report.  This is because if you’re already debt laden the better way to improve your score is to focus on paying down your existing debts in a timely manner.

Pros and Cons of Credit Builder Loans

Credit builder loans have many advantages to consider, but they also come with a few disadvantages as well. When determining if a credit builder loan is the best solution for your financial goals, it's a good idea to review both the benefits and drawbacks. 

What are the benefits of credit builder loan:

  • No credit score requirement: You do not need a certain credit score to be approved for credit builder loans. In fact, many lenders do not require any credit history at all.
  • Build good habits: Because the money is basically being stored in a savings account, you’ll create positive habits that will serve you in other areas like saving, investing and paying back debt. Paying your loan on time and in full can also help build positive payment habits.
  • Lower interest rates: Compared to other loan types and credit cards, credit builder loans usually have much lower interest rates.
  • No hard credit inquiry: Most lenders do not require a credit pull to qualify you for a credit builder loan. This is good news for your credit score since running a credit check can cause a temporary dip in your score.
  • No security deposit: In most cases, credit builder loans do not require you to pay a security deposit or down payment, because of the security offered by the CD the loan is attached to.

What are the downsides to a credit builder loan:

  • Impacts credit score: It’s important to note that credit builder loan payments are reported to credit reporting agencies. This is good news if you’re trying to build credit and you make your payments on time and in full, but it also means that late or missed payments are reported as well, and they might negatively affect your credit.
  • Fees: Like most financial products, credit builder loans often have administrative fees. These fees are usually reasonable, but should be factored into your decision.

How Fast Do Credit Builder Loans Work?

Credit builder loans are designed to help you get started on the path to positive credit history quickly. Most people are able to achieve a credit score within six months of making payments to their credit builder loans. Keep in mind that establishing a good or excellent credit score will take longer,  but we all have to start somewhere. Most credit builder loans range in term from 12 month to 36 months. 

Moreover,  research from the Consumer Financial Protection Bureau (CFPB) indicates those who applied for a credit builder loan increased their likelihood of a positive credit score by 24%. Additionally, those who took out a credit builder loan without any existing debt experienced an increase by 60 points in their credit score and increased their savings balances on an average of $253. 

Open Your Credit Builder Loan at First Alliance Credit Union

If you have no credit history or have damaged credit then a credit builder loan could help you establish a positive credit history quickly, while saving money and avoiding debt. If you'd like more information about how a credit builder loan can benefit you please do not hesitate to contact our team. 

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We do our best to provide helpful information but we cannot guarantee the accuracy or completeness of the information presented in the article, under no circumstance does the information provided constitute legal advice. You are responsible for independently verifying the information if you intend to use it in any way. Additionally, the content is not intended to be reflective of First Alliance Credit Union’s products or services, for accurate and complete details about our product and service information you must speak to an advisor at First Alliance Credit Union.