If you’re struggling with getting approved for a credit card or a loan, it may be because you have less-than-perfect credit.
And unfortunately, having poor credit can make it harder to improve your credit. For example, making regular payments on a low-interest loan could boost your credit score, but your poor credit may keep you from getting a traditional loan in the first place.
Luckily, credit-builder loans can help. Here’s how they work, and how they could help you get back on track.
How do credit-builder loans work?
While regular loans give you a lump sum shortly after you’re approved for one, credit-builder loans work a bit differently. Once you’re approved for a credit-builder loan, the money is set aside for you in a secured savings account or a certificate of deposit (CD) account while you work on paying off the loan.
As you make payments, your lender will report them to the major credit bureaus. Once you pay the loan in full, you’ll get the money to use how you wish.
Credit-builder loans are typically offered in small amounts — usually $1,000 or less — with shorter repayment terms, often ranging from six to 24 months.
However, you’ll pay for the opportunity to borrow money. Lenders will charge you interest and fees, which can vary widely among institutions — but some credit-builder loans will refund you some of the interest you pay. 1st Financial Federal Credit Union, for instance, offers a credit-builder loan with a 12% APR (annual percentage rate) but will refund you half of the interest you pay if you make on-time payments.
How can credit-builder loans affect my credit?
Payment history is one of the biggest influencers on your credit score, so the more payments you make on time, the better. That’s why credit-builder loans can be so helpful — they offer you the opportunity to make regular payments that are reported to the credit bureaus.
But the opposite is also true. If you either miss or are late on a loan payment, your credit score could take a hit.
The whole purpose of a cred-builder loan is to improve your credit, so if you think you’ll struggle with making payments on time, you may want to reconsider if this strategy is right for you.
Where can I get a credit-builder loan?
If you already have an account at a local bank or credit union, see what types of credit-builder loans they offer, if any. Credit unions often offer competitive rates and may be more willing to work with those who have less-than-stellar credit scores. This may entice you to join one before taking out a credit-builder loan.
Some online lenders offer credit-builder loans, too. Self Lender, for example, offers online credit-builder loans for as little as $25 a month if you don’t have any resources in your area.
Other options for building credit
Credit-builder loans can be a helpful way to boost your credit score and get your credit report to start showing positive marks — but they might not be for everyone. Here are a few other ways to build your credit score without taking out a credit-builder loan.
Consider a secured credit card
This type of credit card asks you to make a cash deposit up front, which becomes your credit limit. For example, if you make a $500 deposit, you’ll have a $500 credit limit for your card. You then use your secured card and make payments on it like you would a normal credit card.
But make sure you find a secured card that reports your activity to the three major credit bureaus. That way, your score can go up with good credit behavior.
Become an authorized user
If you don’t have a credit card to build up your credit, enlist the help of someone who does. Ask a friend or relative with good credit if you can become an authorized user on their card. Your name will be added to their account, and their on-time payments will be reported to your credit.
Though you’re authorized to make purchases with their account, use this option wisely. They are responsible for your activity, so if you run up a balance and can’t pay it, they’ll be stuck with your big bill.
Add your regular bills to your credit file
If you regularly pay your household bills on time, consider adding them to your credit report. Experian Boost, for example, is a free tool that allows you to add your utility bills and cell phone payments to your Experian credit report. Experian uses your bank transaction history to determine these payments, so if you pay these bills with a credit card or cash, this tool may not help much.
A credit-builder loan is a great way to build up credit if you have a bad score or don’t have much credit to your name. Finding the right lender is crucial to making sure you have the best opportunity to build or rebuild your credit.
But not everyone qualifies for a credit-builder loan, and you may not have many options near you. In that case, consider other ways of building credit — such as getting a secured credit card, becoming an authorized user, or taking advantage of your current bills by making on-time payments.
Building your credit may take a little bit of time, but you have more resources than you think. Review all your options before deciding if a credit-builder loan is right for you.