What is a credit-builder loan?

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In a Nutshell

Credit-builder loans and savings loans are a type of loan that can help you build or reestablish good credit. Unlike some loans, though, you don’t receive the money upfront when you take out the loan. Instead, you make regular payments to fund the loan over time, with your activity reported to credit bureaus as a way to potentially build credit. But these loans can come with high interest rates and fees, and there’s no guarantee your credit profile will significantly improve.
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A credit-builder loan is a type of loan that can serve as one way to help establish positive credit activity in your credit reports.

Unlike a traditional loan, you don’t get any money upfront. Instead, you make regular payments to fund the loan, and your payments are reported to credit bureaus.

Let’s take a closer look at how credit-builder loans work and what they can do for your credit.

 How credit-builder loans work

A credit-builder loan is a type of loan that’s meant to help you build or reestablish your credit.

Unlike a typical loan, though, you don’t get any money upfront. Instead, you provide the loan amount yourself with regular payments over a set period of time. In the case of some savings loans, those payments might be made into an account that earns interest over time.

The “credit-builder” portion of the loan should occur as you make those regular payments. If your lender reports to the credit bureaus, you can start creating a history of on-time payments that could affect your credit scores and reports.

But keep in mind that these payments aren’t a shortcut to building credit. Credit-builder and -savings loans are one option that can help you start building or rebuilding credit — but you should think about other options that have recurring payments, such as a secured credit card. And if you miss payments or otherwise don’t manage the loan responsibly, you could end up hurting your credit in the long run.

Tips for using a credit-builder loan

Here are some things to consider before taking out a credit-builder loan. 

  • Credit-builder loans may come with high interest rates compared with other kinds of loans, so they can be a costly way to build or rebuild your credit.
  • Credit-builder loans may come with costly fees. You may be charged a loan setup fee for opening a credit-builder loan. To be safe, it’s best to make sure you’re able to make your regular payments and can afford any necessary fees before applying for this loan.
  • Many aspects of the credit-builder loan and whether you make payments on time and use the loan responsibly can affect whether the loan can help you improve your credit.
  • Like other kinds of financial products, a credit-builder loan can hurt your credit if you miss payments or can’t meet the terms of your loan agreement. Make sure the specifics of your loan work for you before agreeing to it.
  • If you take out a savings loan, you may not be able to access your money until you’ve paid the loan in full and your account has matured. You might need to plan your budget well in advance to make sure you’re getting the right kind of loan for your needs.

About the author: Sean Cooper bought his first house when he was just 27 and paid off his mortgage at 30 in 3 years. An in-demand personal finance journalist, money coach and speaker, his articles have been featured in publications suc… Read more.