A credit builder loan is a loan created specifically for individuals with bad credit scores, who will have to actively seek high interest loans if they require one, as opposed to going to a traditional bank. Credit builder loans allow an individual to prove to the banks that they are able to pay a loan month to month, which can then in turn improve their credit rating.
Having a good credit score is crucial in getting loans from main institutions such as banks and credit unions. According to the Bank of America, the better your credit score, the lower your interest will be on a loan such as a mortgage, as illustrated by the table below:
| * | 760-850 credit score | 620-639 credit score |
| APR | 6.458% | 8.047% |
| Monthly Payment | $1888 | $2211 |
| Interest Paid | $379,653 | $496,007 |
*Based on a 30-year fixed rate mortgage for $300,000
For those with bad credit, based on the example above, they could see themselves paying an additional $323 per month and an additional $116,354 overall. This is just one example of how bad credit can affect an individual and why a good credit score is important.
What Is A Credit Builder Loan?
A credit builder loan essentially attempts to overcome the struggles that an individual would have to go through as per the above example. Credit builder loans are meant to help build your credit and allow the banks to trust you more with monthly repayments.
Once you get approved for a credit builder loan, the lender will place the loan amount into a savings account which is held by the bank and not readily accessible by the borrower. You would then make monthly payments on the loan amount until you have paid the entire value of the loan, and then the amount would be given to you, along with dividends or interest in some cases.
What this type of loan does, is shows the lender you are able to make regular monthly payments against a set loan amount over a specific period of time, which ultimately would most likely lead to an increase in your credit score. Usually these loans are between $300 – $1000 and can range from 6-24 months in length.
According to a report by the Consumer Finance Protection Bureau, which investigated credit builder loans, it was found that participants without existing debt saw their credit score increase by as much as 60 points more than those with existing debt.
What Should I Look Out For When Taking Out A Credit Builder Loan?
When taking out a credit builder loan, you do still have to be cautious. While the funds do not get deposited into your account until you have paid the funds to the lender, not being able to make the repayments can in fact impact your credit score even more negatively than taking out the credit builder loan in the first place in some cases.
A credit builder loan is still a loan, so there will most likely be fees and APR that get added on top of the initial loan value. Make sure you understand the full cost of the loan and contact the lender directly if you are unsure of anything.
When taking out a credit builder loan, try to figure out how long you would like to be paying it back for. The longer loan means lower monthly repayments, but in the long run means higher interest and more chances to not pay back the amount each month. Of course, a shorter loan term means less payments, but the payments will be higher each month, so make sure you are comfortable with whichever option you select.
What Are The Alternatives To A Credit Builder Loan?
If you have a bad credit score and do not want to enter into a credit builder loan, there are ways for you to borrow money outside of a traditional finance institution. Several lenders will offer bad credit loans, but the interest rate will be significantly higher in most cases than that of a standard bank loan. This is due to the fact that with bad credit comes concerns regarding difficulty to repay debt, and general affordability.
Loans with bad credit are relatively easy to apply for and can even be done online. All that is required is that you answer the questions honestly, otherwise this can lead to your loan application being denied. You also will need to fit a certain criteria, such as being over 18, have a live checking account to receive funds, be a US citizen, have a steady income of at least $500-800 per month and be able to make the repayments.
Loans for individuals with poor credit can be applied for in several US states, including California, Kentucky and Texas to name a few. If for instance you want a bad credit payday loan, then be aware that all states have different regulations around loan amounts and loan terms. For more information, check out our guide on “What Are The US Regulations For Payday Loans?“
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Justine is a full-time writer with lots of expertise and a wealth of experience in the financial world. In particular, she specializes in household income and consumer finance across the United States. Follow her articles for useful advice and top tips, guides on how to save money and lots more.