Could they raise your score by 60 points or drop it by three? Boosting your credit score is neither tricky nor sexy. It takes organization and discipline.

3 minute read

Nearly a third of Americans have a credit score lower than 601. Credit builder loans are designed to help people who have no credit, little credit, or “colorful” credit. The loans help people build or rebuild their credit score.

Why go through the process? Once your score has improved, you’re more likely to get better interest rates on loans and save a lot of money.

The loan process

Credit unions, community banks, and some online apps/services offer credit builder loans. Consumers can also go to a Community Development Financial Institution (CDFI). All credit builder accounts require an initial deposit (the “loan”) that the person will make payments toward.

Interest rates are usually between nine and 16 percent but can fall outside of this range. Once the borrower finishes making payments, they get the original deposit back. Some services even give back part the interest payments as a reward for on-time payments.

Though it’s all the borrower’s money, the payments still get reported to credit bureaus as if it were a regular loan.

How it can affect credit

With a credit builder loan, the borrower doesn’t get to use any money from the loan until they pay off the loan in advance by sending in monthly installment payments.

As the person makes payments on the loan, the lender reports the payment history to the credit bureaus, and that is what improves a person’s credit. On-time payments make up 35 percent of the FICO credit score, which is the most widely used credit scoring model.

Repayment periods are typically six to 24 months, which should give someone a chance to have a “good credit” signal reported to the credit bureaus. The good news: According to the CFPB, People who did not have any debt who used this type of loan saw their credit scores go up by 60 points.[1]

Not such great news: Consumers who were already in debt found that their credit scores decreased by about three points.

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When to get a credit builder loan

Considering that it could help or hurt your credit, how do you know if it’s right for you?

A credit builder loan is something to consider if you:

  • Don’t have a credit history yet.
  • Are not carrying any other debt.
  • Have no debts reported to the credit bureaus.
  • Can afford to make the monthly payment.
  • Commit to pay the loan on time every month for the life of the loan.

Now, if you have debt reported to the credit bureaus, your budget is tight, and you are late on payments, you probably want to pass.

“Borrowers with existing loan obligations were more likely to struggle to incorporate the credit builder loan into their payment obligations, for example by making a late payment on a non-credit builder loan, ” the CFPB said. The CFPB also found that four out of ten people who took out a credit builder loan missed payments, which hurt their credit more than helped it.

Surprisingly, about 45 percent of those who didn’t carry any other debt wound up missing at least one payment on their credit builder loan. You can read more about the survey outcomes here.

Another caveat is if you have a history of bouncing checks, you might not get past the initial ChexSystems bank screening at all. So, if you are thinking about getting a credit builder loan to improve your credit score, you’ll need to evaluate if it is really the right move for you.

In the end, paying current obligations on time should still be your main priority.

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About the Author’s writers are journalists, personal finance experts, and certified credit counselors. Their advice about money – how to make it, how to save it, and how to spend it – is based on, collectively, a century of personal finance experience. They’ve been featured in media outlets ranging from The New York Times to USA Today, from Forbes to FOX News, and from MSN to CBS.

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