Banking and Finance

What is a Credit Builder Loan?

July 27, 2021

Have poor credit? Don’t have any credit at all? There are a few ways that you can increase your credit score, and a credit builder loan is one of them. 

In fact, a report published by the Consumer Financial Protection Bureau looked at the credit score of 1,500 consumers. Those who started out with no credit and then took out a credit builder loan saw their score increase by at least 60 points.

While there are a few different reasons as to why you would take out a credit builder loan, it’s important to understand what they are first, how they work, and how to use them to your benefit. Sit tight and we’ll answer all of your questions below.

How Does a Credit Builder Loan Work?

If you know what a traditional loan is, where they give you money that you pay back over time, then just think the opposite. That’s a credit builder loan. Instead of applying for a loan, where you would normally be approved for, let’s say, $10,000 and then receive that $10,000 to use and pay back over time, with a credit builder loan, the amount you take out is held in a bank until you finish making payments on it. Then, you can access the money.

Usually, the money is held in a secured savings account or certificate of deposit (otherwise known as a CD). The loan will be in your name and you will make agreed-upon payments until it is repaid. Then, you can access the cash. It’s important to also keep in mind that even though you can’t use or spend the money until you’ve fully repaid the loan, you will still be charged APR on it, which is typically higher than normal loans. Credit builder loans are known to have between 6-16% APR, so you’ll need to be mindful of those fees in relation to how long you plan to take to pay off the loan.

Who is Eligible for a Credit Builder Loan?

Because these types of loans are designed for those with poor to no credit, having a high credit score isn’t a requirement for a credit builder loan. To be eligible for a credit builder loan, you typically only have to be over the age of 18, have a valid bank account, and show proof of sufficient income that shows you will be able to pay the loan back without problems.

It’s important to note that, for most types of loans in the United States, you do need to often be a citizen to access the funds. However, if you have an ITIN number, you are likely eligible for an ITIN loan. Alternatively, more and more companies are now offering easier access to loans and credit builder loans for immigrants. Citizen Path offers helpful insight into how you can build credit as an immigrant without a SSN.

What Are the Requirements for a Credit Builder Loan?

As mentioned above, the requirements for a credit builder loan are quite minimal, mainly because they are designed for those who have poor or no credit. To take out a credit builder loan, we suggest you:

  • Find a financial institution offering credit builder loans. Typically, you’ll have to look at smaller banks or community banks as large banks don’t offer these types of loans.
  • Determine the amount of money you’d like to borrow. Usually, credit builder loans don’t exceed $1,000. So, these aren’t loans that you’ll take out to help you make a large payment or to pay off high-interest debt. Nope. These loans really are to, well, help you build your credit!
  • Follow the guidelines for the application process with the financial institution of your choosing. Normally, the application process for a credit builder loan is a lot quicker and easier than it is for a regular loan. You’ll be required to provide your personal information along with details about your income, at the very least, though.

Can a Credit Builder Loan Actually Help You Improve Your Credit Score?

As mentioned in the study above, for consumers who started out with no credit and then took out a credit builder loan, they saw their score increase by at least 60 points. So, there is hope! However, what’s most important when taking out a credit builder loan is keeping in mind one thing: you have to make sure you make your payments on time!

On-time payments are one of the biggest factors that affect your credit score. So, if you miss a payment when repaying your loan, it’s going to negatively affect your score. And, that’s the last thing you want in this situation. We suggest setting up autopay if possible, or being mindful about setting reminders on your phone or calendar so that you absolutely never miss a payment.

The good news about credit builder loans, though, is that monthly payments are often as low as $25. So, if you don’t have much extra cash to put towards paying off the loan, the payment shouldn’t put too much of a dent into your savings each month.

Improve Your Credit with Cheese

While we can’t help you build credit you don’t already have, we can help you monitor and track changes in your credit score. Once you’ve taken out and repaid your credit builder loan, be sure to check out our upcoming credit builder feature that will allow you to easily track changes in your score straight from the Cheese app.

The best part? It’s all going to be integrated into the Cheese app, making it easy to use and easy to access. Click here to be one of the first users who gets access to this helpful new feature.