What Is a Credit-Builder Loan and How Does It Work?

By Upstart Content Team | Updated December 10, 2022
reading time 6 min read
Grey haired older woman looking up credit-builder loan on laptop

Key takeaways: 

  • A credit-builder loan is a loan made for borrowers with little or no credit history.
  • Making timely payments on a credit-builder loan can help establish or boost your credit score.
  • Personal loans and secured credit cards are alternative ways to build or raise your score.

If you have little or no credit history, accessing affordable financing—like a loan or credit card—can seem difficult. Fortunately, a credit-builder loan may be able to help.

In this guide, we’ll take a closer look at credit-builder loans, how they work, and how to decide if it’s right for you. Read on for everything you need to know.

What is a credit-builder loan?

A credit-builder loan is a low-dollar installment loan designed for people with little or no credit history. Also known as a “fresh-start loan,” these loans are often offered by small financial institutions, like local credit unions or banks.

How do credit-builder loans work?

Unlike a traditional loan, you don’t receive the money from your credit-builder loan after your application gets approved. Instead, your loan provider holds the money in a special savings account. Then you make monthly payments on your loan principal.

You can’t access the money from your credit-builder installment loan until you’ve paid off your loan in full. However, your loan provider will track and report each payment to the three major credit bureaus: TransUnion®, Equifax®, and Experian™.

Reporting your payments allows you to build your credit profile—as long as your payments are timely. Late payments can lower your credit score and lead to derogatory marks on your credit report.

Once you’ve reached the end of the loan term, your loan provider will release the money to you. In some cases, you may even be refunded a portion of your interest payments.

Is a credit-builder loan a good idea?

Taking out a credit-builder loan can have some benefits, especially if you don’t have a solid credit history. Because your loan provider doesn’t release the funds to you right away, there’s significantly less risk on their part. So you stand a better chance of getting approved, even if you don’t have a good credit score.

Still, getting a credit-builder loan is a big financial step. Consider the following questions before applying for a loan:

  • What type of credit-builder loan will work best for me? Take some time to consider different loans, loan amounts, and terms before choosing one that suits your needs.
  • Can I afford the loan payments? Making timely payments on your credit-builder loan can help you build or boost your credit score. But if you can’t afford your payments, you could risk falling behind on your loan. With that in mind, make sure you understand the true cost of borrowing, including the fees and interest charges. 

    Build these expenses into your budget to avoid missing payments or stretching your budget too thin. Make sure your lender reports your payments to all 3 credit bureaus to get the ultimate boost to your credit score, too.

  • What will I do with the loan proceeds? Finally, take some time to consider what you’ll do with your loan proceeds. Once you payoff the loan in full and receive the funds from your lender, you can use the money to establish an emergency fund, pay for a wedding, or take on a home improvement project.

Where to get a credit-builder loan

Finding a credit-builder loan isn’t always as easy as a standard loan, so prepare to spend some time searching for a reputable lender. Some of the most common credit-builder loan providers include: 

  • Credit unions: Local credit unions and community banks may provide credit-builder loans for applicants with a poor or thin credit history. Credit union loans often come with lower rates and optimal repayment terms. However, credit unions may have membership requirements that you must meet before you can take out a loan.
  • Online lenders: Some online loan providers offer credit-builder loans. Taking out a loan from an online lender may be simpler, too. You can often complete the application, get approved, and start making payments from your computer or mobile device. 

    All online lenders aren’t licensed in every state, so do your research before selecting a provider. In addition, payment terms and annual percentage rates (APRs) can vary widely. Make sure you compare offers before accepting a loan.

  • CDFIs: Community Development Financial Institutions (CDFIs) are organizations that support lower-income communities. They exist throughout the United States and may offer credit-building loans and other services to qualified applicants.

Will a credit-builder loan hurt my credit score?

Applying for a credit-builder loan may cause your credit score to drop. That’s because some loan providers run a hard credit check when reviewing your application, which will appear on your credit report.

Keep in mind that this drop is temporary. Your score will likely recover quickly, especially if you make timely payments on your credit-builder loan. It’s important to make your payments on time, every time. Missed payments can cause your score to drop significantly and place a derogatory mark on your credit report.

Can you get credit-builder loans with no credit check?

While it’s not always the case, you may be able to get a credit-builder loan without a credit check. That said, these loans are designed for folks who want to rebuild their credit, so a credit check may not affect your ability to borrow.

Alternatives to credit-builder loans

Not sure if a credit-builder loan is right for you? Not to worry. Consider the following ways to start building credit:

Apply for a secured credit card

A secured credit card works similarly to a traditional credit card, with one exception: A secured credit card requires you to make an up-front deposit. This deposit becomes your credit limit.

You can use a secured credit card exactly like you’d use a traditional credit card. But unlike a traditional credit card, a secured card protects your issuer from losing money if you’re unable to repay your balance.

Typically, secured credit card issuers report your payment history to the credit bureaus, which can help strengthen your credit report. Your issuer may even convert a secured card to a traditional credit account after making on-time payments for several months.

Take out a personal loan

A personal loan is a type of loan you can use to make purchases, cover unexpected expenses, or boost your credit score. Personal loans may be secured or unsecured. Secured loans are backed by collateral, like your home or vehicle. Unsecured loans aren’t backed by personal belongings and may come with slightly higher interest rates or fees.

Traditionally, loan providers base the cost of your loan on details like your credit score and payment history. That means it can be difficult to qualify for an affordable loan if you have limited credit. But that’s not always the case.

Lending marketplace like Upstart, look beyond your credit score and use your work experience and education¹ to help you find a loan. As a result, you could qualify for a loan that you may not have qualified for with a traditional lender.  We also report your payment activity to the credit bureaus, possibly allowing you to build or boost your score with on time payments. 

Do personal loans build credit?

When used responsibly, a personal loan can help you build your credit score—as long as your loan provider reports your payments to the credit bureaus. 

Making timely payments on a personal loan or other forms of debt (such as credit cards) has a direct impact on your credit score. In fact, payment history makes up 35% of your FICO® Score, the credit score model used by most lending and credit card companies. With that in mind, it’s essential to stay a step ahead of payments to avoid late or missing installments.

Become an authorized user on an account

Finally, you may consider asking a family member or friend to add you as an authorized user on their credit accounts.

When you become an authorized user on an account, the account’s history gets added to your credit report. That means the primary account holder’s financial habits can help boost your credit profile almost immediately.

The account holder doesn’t even have to give you a credit card, nor do you have to make any purchases or payments. Simply adding your name to the account allows you to take advantage of their repayment history and responsible credit usage.

Bottom line: Should you take out a credit-builder loan?

A credit-builder loan can help you establish or boost your credit profile. However, it’s important to consider your current financial situation, needs, and available offers before agreeing to a loan.

Most importantly, make sure you find a reputable loan provider. Otherwise, you could face sky-high interest rates or repayment terms that make it difficult to pay off your debt.

And if you don’t think a credit-builder loan is right for you, you’ve got options. Becoming an authorized user on a loved one’s credit account can provide a relatively easy path to a better credit score. 

Similarly, an unsecured personal loan through a lending marketplace like Upstart could help you boost your score through debt consolidation and/or timely payments. No matter which type of credit-building tool you choose, you’ll be one step closer to a solid financial foundation.

¹ Neither Upstart nor its bank partners have a minimum educational attainment requirement in order to be eligible for a loan.

This content is general in nature and is provided for informational purposes only. Upstart is not a financial advisor and does not offer financial planning services. This content may contain references to products and services offered through Upstart’s credit marketplace.

About the Author

Upstart Content Team

The Upstart Content Team shares industry insights, practical tips, and borrower success stories to help people better understand the important “money moments” of their lives.

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