How Credit Builder Loans Work

Written by Banks Editorial Team
4 min. read
Written by Banks Editorial Team
4 min. read

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Your credit score is one of your most important financial numbers. It impacts the car you drive, where you live, and your monthly budget. Lenders assess your score before giving you a loan, and most lenders have minimum requirements. Some people may not have high enough scores to qualify for a mortgage or auto loan. Even if you have a qualifying credit score, barely making the mark will result in a higher interest rate. 

Borrowers often work on their credit scores before applying for a loan. A higher credit score leads to lower interest rates and can reduce your down payment. Millions of borrowers use credit builder loans to fortify their credit and qualify for better financing. With this loan and the right plan, you can unlock the financial benefits of a high credit score.

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What is a Credit Builder Loan?

A credit builder loan is a low loan amount designed to improve your credit. Most lenders only give you $1,000 and expect monthly payments. Each monthly loan payment strengthens your credit history since the creditor will report your payment activity to the major credit bureaus. As a result, the credit bureaus will see that you can handle debt and increase your score. Payment history makes up 35% of your credit history, making debt repayment one of the best ways to improve your credit score.

The lender does not give you the loan proceeds right away. Instead, credit builder lenders put the loan’s principal into a separate bank account. As a result, you can only access the loan’s principal after you fully pay off the loan. This structure prevents borrowers from falling deeper into debt while rebuilding their credit.

What is the Difference Between a Credit Builder Loan and Other Loans?

Any loan can improve your credit score, but some loans have stringent requirements. Credit builder loans offer a lower barrier to entry for borrowers. Credit builder loans are primarily for people who want to build their credit, while people take out other loans for different purposes. Those other loans will improve credit with on-time payments, but borrowers take out other loans for homes, vehicles, vacations, and other expenses.

Credit builder lenders don’t give you the money right away. You have to pay the loan first before receiving the principal. This setup reduces the lender’s risk and provides borrowers with a way to build their credit. Other loans have quicker turnarounds for the principal. You can receive the proceeds within a few days and use them right away. Some loans require collateral, especially mortgages and auto loans. Credit builder lenders will not ask for any personal items as collateral but will keep the principal until you pay off the loan. 

How Does a Credit Builder Loan Help Build Credit?

Lenders report your payment history to the major credit bureaus. On-time payments will improve your credit score over time and demonstrate effective debt management. Your credit score won’t suddenly skyrocket, but if you build up strong payment history over several months, you can see noticeable improvements. Building your credit requires a long-term focus.

If your credit has taken a hit in the past, a credit builder loan is a great starting point for recovery. Most creditors offer these loans to people who had a rough break and want to improve their score before applying for a conventional loan. 

Some Things To Consider When Getting a Credit Builder Loan

A credit builder loan can rebuild your credit, but some loans become more trouble than they’re worth. Before working with a lender, you should look through several credit builder loan options. These factors will influence whether a credit builder lender is right for you.

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Fees and Other Costs

You will incur origination fees and other costs for taking out a loan. These initial fees aren’t expensive but will increase your total costs. You should also check late fees in case you can’t make payments. If you feel nervous about late fees, you should consider a smaller loan or wait until you have enough reserves.

Minimum and Maximum Loan Size 

Most lenders set $1,000 as the maximum size for a credit builder loan, but some stretch the loan to a higher amount. Some borrowers don’t have much money to spare and would prefer to pay as little as possible. They can opt for the minimum loan amount instead, but this number will vary for each lender. Selecting a smaller loan amount reduces your monthly payments and helps you save more money. However, a larger loan amount can demonstrate your ability to handle more debt and raise your credit score faster. 

Monthly Payments

The Credit Builder Loan will take up space in your monthly budget. You should consider how much you can afford to pay before taking out a loan. Borrowers can reduce their monthly payments by selecting smaller loan amounts with longer durations and lower APRs. You should compare creditors to see which one offers the most attractive monthly payment plans for your objectives.

Annual Percentage Rate (APR)

Lenders set APRs on their financial products to achieve a return on their investment. Every lender uses this business model, but some creditors set unreasonably high APRs. You can compare rates across credit unions, online lenders, and other financial institutions. Most lenders will set double-digit APRs for credit builder loans since borrowers with lower credit usually apply for these loans. A high APR has less of a sting if you take out a smaller loan amount or use a shorter loan term.

Interest Charge Back

Despite their best efforts, some borrowers fall behind on credit builder loan payments. The lender usually cancels the loan and repays your previous loan payments. Unfortunately, the lender will charge interest and a penalty for this chargeback. Most borrowers should not take out a loan if they’re nervous about the interest chargeback, but it’s a scenario worth considering. You should review each credit builder loan to ensure you work with a creditor that has a reasonable interest chargeback policy.

Where To Get a Credit Builder Loan

A credit builder loan can create new possibilities. Adding points to your credit score can significantly impact your life. Landlords usually look at your credit score before deciding if you can live on their property. A higher credit score can help you get financing which can make or break your ability to purchase a house or vehicle. Credit builder loans help you on your financial journey, and MoneyLion can provide you with a loan.

MoneyLion’s credit builder loans do not require a hard credit check. Their soft pull will not impact your credit score, and you can borrow up to $1,000 with one of their loans. In addition, unlike most credit builder lenders, MoneyLion lets you immediately access some of the loan proceeds. You can use these proceeds to cover several loan payments and simplify repayment.

MoneyLion offers a suite of financial resources that will improve your credit and strengthen your personal finances. You can access your financials on a single dashboard and receive insights that help you monitor your financial health. You can get a credit builder loan and MoneyLion’s other features by downloading the MoneyLion banking app today.

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