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How to Establish Credit with a Credit Builder Loan

Getting loans, credit cards and other types of credit can be difficult for borrowers without a good credit history.

Trying to get approved for credit can be a sort of Catch-22: Creditors want proof that you’ve handled a credit card well before, but without a credit card already in hand it can be hard to show you’re a good risk.

Table of Contents:

  • What is a Credit Builder Loan?
  • How Long Is a Credit Builder Loan?
  • Who Needs a Credit Builder Loan?
  • Importance of Credit History

What Is A Credit Builder Loan

Credit-builder loans are sometimes offered by community banks and credit unions as a way to give borrowers a chance to show they can make regular payments and complete a loan, and ultimately be able to build or rebuild a positive credit history.

Credit builder accounts work like this: It’s a small loan that as you pay to yourself. You make payments that are held in an FDIC insured CD account, in your own name.

Credit-builder loans can help you establish needed credit. Using a credit-builder loan well can improve your credit score, though it can take a year to do it.

That may be OK if you don’t need a credit card or mortgage immediately, but if you need credit now or are shopping for a house, a year can be a long time to wait.

How Long Is A Credit Builder Loan?

The loans aren’t about having a need for the money being loaned, but to improve a credit score.

Loans can be small amounts such as $500 to $1,500, or some as high as $5,000. You will make payments over the term of the loan which might be a year or a different timeline.

The lender puts the payments from a traditional credit-builder loan into a certificate of deposit, which may earn interest and is given to the borrower when the loan is paid off, usually within a year. Borrowers won’t have access to the money over the length of the loan, such as 12 months.

To be clear — you don’t get the loan amount when closing the loan, as you would with a traditional loan, but get the money from the credit-builder loan when you pay off the lender completely.

Who Needs a Credit Builder Loan?

People who are trying to establish credit or rebuild credit after such major problems as bankruptcy may want a credit-builder loan. Or the loans can help people trying to build credit for the first time in their lives, such as recent college graduates, the newly divorced or immigrants new to the country.

Recent college grads, for example, who don’t have credit cards can use a credit-builder loan to establish a positive credit history and then have an easier time renting an apartment or getting a mobile phone account. These types of first-time borrowers will likely see a bigger boost in their credit score than someone who’s rebuilding their credit.

A source of income that allows monthly payments of $50 to $100 for the term of the loan is needed. Having unresolved financial judgments can make it difficult to get a credit-builder loan.

If you have unresolved financial judgments against you, it can be difficult to get a credit-builder loan. Pay those debts off first before applying for one.

Importance of Credit History

Good credit history is one of the major parts of what makes up your credit score. Did you know payment history makes up 35% of your FICO score?!

Ultimately, credit-builder loans are a great first step which might lead to getting unsecured credit cards or larger loans such as a car loan within a few years. And then, with a good or excellent credit score in hand, you’re more likely to get the best loan rates and possibly the best credit cards as lenders seek out your business.