What is a credit-builder loan?

With a credit-builder loan, you make fixed payments to a lender and then get access to the loan amount at the end of the loan term. That’s different from typical loans, which involve borrowing money upfront and then repaying it over time.

What you’ll learn:

• A credit-builder loan gives you an opportunity to show that you can make consistent, on-time payments. 

• Because payment history is an important factor in calculating credit scores, credit-builder loans can be used to build credit.

• Banks, credit unions, online lenders and financial technology companies may offer credit-builder loans.

• Good credit scores aren’t required to open a credit-builder loan. But sometimes upfront fees are required.

Unlike a typical loan, a credit-builder loan involves a lender depositing the loan amount into a certificate of deposit (CD) or savings account, which the borrower can access only after repaying the loan. 

Here’s a look at how credit-builder loans work if you’re approved:

• Your lender sets aside the money: Your lender will set up a savings account or a CD with the loan amount—usually $300 to $1,000, according to the Consumer Financial Protection Bureau. Depending on the account and the lender, the loan might earn interest.

• You make monthly payments: You’ll make payments with interest on the loan in installments, usually over six to 24 months.

• Your lender reports your payments to the credit bureaus: Your lender should report the details of your payments, including whether they’re on time, to at least one of the three major credit bureaus every month.

• You get access to the money: If you’ve made all your payments on time by the end of the loan’s term, your lender will make the funds available to you.

A credit-builder loan is a type of installment loan and, in most cases, lenders report payments made on the loan to the credit bureaus. So whether you’re building credit from scratch or rebuilding your credit, a credit-builder loan allows you to demonstrate that you can handle making consistent, on-time payments, which can help you create a positive payment history.
Your payment history is a key factor in calculating your credit scores. If you make a late payment or miss a payment altogether on your credit-builder loan, your lender will likely report it to the credit bureaus, which could hurt your credit scores.

You may be able to find credit-builder loans at:

• Community banks

• Local credit unions

• Online lenders

• Financial technology companies that specialize in helping people build and rebuild their credit

Credit-builder loans may not be advertised, so you might need to inquire directly with banks or credit unions to find them.

A credit-builder loan won’t typically require a credit check, so that can make it easier to qualify for than other types of loans.

Lenders might look at your banking history through a consumer reporting agency—like ChexSystems. And when you apply, you’ll likely be asked to provide things like employment information and proof of income. You may be asked for other information too, such as loan balances and checking and savings account balances.

It’s also worth noting that you may have to pay an upfront fee when opening your credit-builder loan account.

Credit-builder loans can be a helpful option if you are credit invisible or want to raise your credit scores. If you have the income for regular on-time payments, a credit-builder loan may be an option worth exploring.

But be aware of interest rates and annual percentage rates, which can add costs to your loan.

A credit-builder loan is just one option for building credit. Whether you have poor credit or no credit history, here are some other ways you might be able to help build or rebuild your credit:

If you’re approved for a secured credit card, you get access to a line of credit upfront, possibly without an annual fee. However, a secured card typically requires you to pay a refundable security deposit to open the account. 

For example, the Platinum Secured card from Capital One has no annual fee and can be accessed with a security deposit of $49, $99 or $200. View important rates and disclosures. And if you use your credit card responsibly, you can earn back your deposit as a statement credit. Otherwise, it’ll be refunded when you close your account and pay your balance in full.

Depending on the lender, you may qualify for a personal loan even with poor or no credit. Unlike credit-builder loans, personal loans provide access to funds upfront, which you repay over time.

While personal loans could help you build credit, the options might be limited. For example, if you only qualify for a secured loan, it will require collateral, which means that if you default on the loan, you’ll likely lose your collateral. 
Keep in mind, some personal loans, like payday loans, carry unique risks and are less likely to help you build credit.

Becoming an authorized user on the credit card account of someone you trust can help you develop responsible credit habits. However, it’s important to first verify whether a card issuer reports authorized users to credit bureaus.

Once you’re an authorized user, the card’s account history may be added to your credit reports, although the primary cardholder is responsible for making payments. If you and the primary cardholder use the card responsibly, it could help you build credit. But irresponsible use could hurt your and the primary cardholder’s credit.

A credit-builder loan can be an excellent tool for helping you build or rebuild your credit. But there are other credit-building options out there too. No matter which ones you consider, be sure to do your research so you can make an informed decision on the best credit-building choice for you.

If a credit card geared toward improving your credit seems like a good option for your needs, explore the potential benefits of Capital One’s cards for building credit and consider getting pre-approved today.