By Cullen Canazares On Thursday, February 01 st, 2018

Build credit with a credit-builder loan

A credit builder loan is a small loan with a large range of interest rates

If you have poor credit, a thin credit file or no credit history, you might need a credit builder loan. What is a credit builder loan? Credit builder loans are small loans, typically made by credit unions and small banks, which are offered to clients who need to establish or boost their credit file.

There are two primary types of credit builder loans, and each type offers unique financial benefits.

As an example, an unsecured (meaning no loan collateral is required) credit builder loan offers a lump sum upfront that can be used toward an emergency expense — medical emergency, a car repair, new appliance or any other unexpected expense.

The second type of credit builder loan actually ‘freezes’ the loan proceeds until the total amount has been paid off, thus forcing you to save your money.

Credit Builder Loans

The basics of credit-builder loans

Credit-builder loans usually are offered in modest amounts. They can range from a few hundred dollars up to about $1,500. Most people who use these loan types are people who need to build a credit history, but have their overall financial situation under control. In other words, if you are obtaining a credit builder loan, you are likely through the worst of your financial challenges and are now seeking to improve your credit score.

Credit unions who underwrite these credit builder loans want to see some stability to these borrowers, too. For example, most credit unions will require that a borrower has been a member of the credit union for at least three months, has a minimum of six months at their current job (or residence), and has no recent checking overdrafts. As with most loans, interest rates will vary based on the level of perceived risk of lending to you, but they will be lower if you are obtaining a secured loan versus an unsecured loan – logically. Also, many credit unions will allow you to first obtain a secured credit builder loan, and then grant you an unsecured credit builder loan at a more favorable interest rate. However, you should not be shocked if the rate of that first loan is upwards of 19-20%.

Credit Builder Loans

Your Options

Generally, credit building loans are structured in one of three ways:

  1. A credit builder loan secured by the loan funds: With a “pure credit-builder loan,” the lender puts the loan amount in a locked savings account and gives it to the borrower only after receiving the final payment. For example, ENT Credit Union offers credit builder loans in the amount up to $2,500 for 24 month terms at 2.99% Interest. However, there are two positives — you don’t have to have cash upfront to secure the loan, and you end up with a nice little nest egg at the end.
  2. A standard secured credit builder loan: This type of loan is secured by money that you have (usually in a savings account or certificate of deposit, or CD). For example, Alpha Bank could offer a secured credit-builder loan at an APR of 11 percent PLUS the interest rate on the savings account being used as collateral. Then, the saving account (which is now the ‘collateral account’) is frozen, but those funds are released incrementally as the loan is paid down. If you have the money to secure the loan, this is a solid option.
  3. An unsecured credit builder loan: Unsecured credit-builder loans work well for consumers who need cash upfront and now. Yes, you get the loan, and you could have the money in your pocket that same day, but you may not qualify at all for this type of loan. However, unsecured credit-builder loans provide an excellent alternative to payday loans, as long as you can (a) get the loan,  and (b) afford the payments.

Should credit builder loans be a part of your overall credit rebuilding strategy?

Are You Paying Renting?

Get credit for the rent you pay! This is where Rental Kharma comes to your aid. Unlike these other methods where someone has to first borrow money to build a credit history, Rental Kharma gets your rental history payments added to your credit report. This helps you get credit for PAST payments of rent, and boost your score 30-50 points. See what others say about getting credit for rent payments.