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Rebuild Credit with a Credit Builder Loan

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Your local credit union may be able to help you rebuild credit with a Credit Builder Loan. A good mix of credit experience can help your FICO score.

Credit builder loans are small loans ranging from $500 to $3,000. The repayment terms can be from 6 months to 36 months. Interest rates may be slightly higher than good-credit loans but the cost can be worth it for a boost in FICO scores.

The purpose of a credit builder loan is to build or rebuild credit and improve credit scores. Rebuild credit with a credit builder even if you have bad credit. But not all credit unions offer credit builder loans. You will have to do some research to find a credit union offering such loans.

How it Works

The credit union grants a loan for a certain amount — let’s say $3,000. The credit union would not actually give you the money. The money would be frozen in an interest-bearing savings account in your name.

You would then make the payments; with interest, until the $3,000 loan is paid off. At the time of payoff you would then get the money, along with whatever dividends have been earned on the savings deposit. Borrowers have an excellent chance to build a positive credit history if payments are made on time.

Other credit unions may offer credit builder loans in which the borrower puts an amount of money upfront to the credit union; perhaps $300 or so, and the credit union deposits the money into an interest-bearing savings account as collateral. The credit union would then provide a line of credit up to the amount the borrower placed upfront and the borrower makes monthly payments.

Community Trust Credit Union in Oakland, CA offers a credit builder loan called the “Fresh Start” loan program. The loan is secured with a deposit ranging from $500 to $3000. The terms of the loan can be either 12 months or 24 months. The funds are placed on hold in a savings account and the borrower’s monthly loan payment activity is reported to the credit bureaus. Community Trust Credit Union is one example of how a credit builder loan works.

How FICO Scores Improve

As you repay on time, you establish a positive payment history which is reported to the credit bureaus. Not only does your credit history improve but your FICO score also improves. As long as you pay on-time and keep credit card account balances to no more than 30% of the available credit limit, you will get a boost in scores.

Personal loans are considered installment loans. Having a good mix of credit helps your FICO scores. Ideally a consumer credit report should consist of both revolving accounts (bank credit cards, retail store and gas cards alike) and installment accounts (personal, auto, mortgage and even student loans). Credit mix accounts for 10% of your credit score. Credit mix enters the scoring formula because of how the different financial management behaviors required for each can impact the ability to pay on time. It may be easy for a consumer to pay a credit card on-time but throw in an installment loan, with fixed monthly payments, that consumer may have difficulty keeping up. The credit scoring formula likes to see some experience successfully managing both revolving and installment types of credit.

Why would a consumer pay for a loan they cannot immediately use? The quick answer is that your credit score will improve. But you also get the added benefit of putting money away because once the loan is paid in full — you get access to the money plus whatever savings interest rate the credit union pays. There is little risk to the bank because they did not provide the actual money upfront to the borrower. Think of a credit builder loan as the old-fashioned layaway.

How to find a credit builder loan

According to Steven Rick, a senior economist at the Credit Union National Association, nearly 15% of the 7,400 credit unions in the United States offer a credit builder program.

You will have to call a credit union to find out if they offer credit builder loans. You can find out if you are eligible to join a credit union through website. Other financial institutions that may offer credit builder loans is a community bank or certified community development financial institution. These types of banks typically cater to low-to-moderate income households.

In case you cannot find a credit builder loan or a credit union you are eligible to join, a secured credit card can also help rebuild credit. The concept is similar in that you put money upfront in a savings account as collateral; however, with a secured credit card, you are eligible to use the credit line established by your savings deposit collateral.

The available credit line of the secured card is equivalent to the savings account deposit. With either a credit builder loan or a secured credit card make sure the bank reports payments to at least 2 of the major credit bureaus. The purpose of such credit rebuilding products is to improve your credit score; that can only be done if the payment history is reported to the credit bureaus.

As a last option if you are unable to find a credit builder loan at a credit union or put the money on deposit for a secured credit card; there are bad credit personal loans. A bad credit loan will come with less favorable terms such as high interest rates but it can work in your favor if you make timely payments to improve your credit score and pay it off early.

Consider building or rebuilding a positive credit history with a credit builder loan. But keep in mind if you pay late, the loan may end up hurting your credit score. The good thing about most credit builder loans is that you can usually stop the loan if you can no longer afford the payments.

Credit Builder Loan Overview

  • The amount you borrow is deposited into a Savings Account that you cannot touch until the loan is repaid.
  • You make regular on-time payments on the loan.
  • As you repay on time, you establish a positive payment history that is reported to the credit bureaus.
  • Based on those reports, your credit history and credit score improves over time.
  • When you finish repaying the loan, you’ll have the full balance in the Savings Account, including dividends, to use as you please.
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