Credit-builder loans: how they work and what they cost

According to the CFPB, a good credit history helps you get housing, bank accounts, credit cards and loans, and lowers the interest you pay.¹ If you have no history, nobody can see that you pay on time. The credit-builder loancredit-builder loanA credit-builder loan helps you create or improve your credit history and save at the same time. Some banks and credit unions offer them. Unlike a secured card, you do not make an opening deposit: the lender puts the loan amount in a locked savings account and you pay it off in small payments. Then you receive that money, minus any interest or fees. The lender reports your payments to the three nationwide credit reporting companies. In a CFPB study, these loans helped people with no other debts the most.See the full definitionClose is one of the tools designed for getting started. This guide explains how it works month by month, which costs to check, what the CFPB found about who it helps most and where to find one.

How long the loan usually lasts

6 to 24 months³

The amount the lender usually holds in the locked account

$300 to $1,000³

The nationwide credit bureaus that receive your payments

3 bureaus¹

Of people who opened the loan in a CFPB study made at least one late payment

39%³

What a credit-builder loan is

It is a loan that works in reverse. With a normal loan you get the money and then pay it back. With this one, according to the CFPB, you build credit and savings at the same time: the money is not for spending but is held for you as savings while you make small payments, usually over six to 24 months. At the end, you receive the full amount you paid.¹

They are offered by financial institutions, typically credit unionscredit unionA credit union is a not-for-profit financial institution that, like a bank, accepts deposits, makes loans and offers other services, but is owned by its members. Members elect a volunteer board of directors, and profits go back to them as lower fees, higher savings rates and lower loan rates. To join you need a common bond, such as your employer, your family, where you live or a group you belong to. It is chartered by the NCUA, a federal agency, or by a state. If the credit union is federally insured, your deposits are protected by the NCUA's insurance fund.See the full definitionClose, which deposit a small “loan,” often $300 to $1,000, into a locked savings account.² Your payments are reported to the three nationwide credit reportingcredit reportA credit report is a statement that has information about your credit activity and current credit situation: your loans and cards, the balances, whether you have paid on time, accounts in collection and who has checked your credit. Credit reporting companies, also called credit bureaus, compile it from what banks and creditors report; your credit score is computed from it. When you apply for a mortgage, the lender pulls your report from the three bureaus. You have the right to see it for free and to dispute anything that is wrong.See the full definitionClose companies, which create a report in your name; paying on time, every time, helps you build a strong credit historycredit historyYour credit history is the record of your credit accounts and of whether you paid them on time, as shown in your credit report. Credit reporting companies collect and update this information and provide it to other businesses, which use it to make decisions about you. A good history helps you get housing, bank accounts, cards and loans, and lowers the interest you pay. If you have no history, or very little (a thin file), there may not be enough information to produce a score. Paying with a debit card, cash or a prepaid card usually does not build it.See the full definitionClose.¹

The CFPB lists it, along with the secured credit cardsecured credit cardA secured credit card is a card that helps you start or rebuild your credit history. To open one, you put a deposit in an account, usually equal to your credit limit, which starts out small. You can spend up to that amount and, when you pay the bill, that room becomes available again. Payments are reported to the credit reporting companies, so paying on time helps. As you show you pay on time, your limit may go up and your deposit may be refunded. Fees and interest rates can be high. A prepaid card is different and does not build credit.See the full definitionClose, among the products designed for people new to credit or who need to improve it.¹⁰ The credit from zero guide lays out the full plan for getting started.

How it works, month by month

The CFPB studied these loans and describes their parts in a 2020 report. What defines them is that you pay before you get the money.³

Example with real numbers

A credit-builder loan, start to finish

How it works inside, according to the CFPB's description. Amounts, terms and fees vary by lender.

When you open it

The lender puts its own money in a locked savings account in your name

Each month

You make a payment that includes interest and fees

After each payment

The lender reports it to the three credit bureaus as an installment loan

The money

Moves to your savings account after each payment or all at the end, depending on the lender

When you finish

You have the savings and a history of on-time payments, if you paid on time

This is a general description.³ Before you sign, ask in writing for the APR and the total of payments on your offer.⁴ Build your credit plan with your own numbers.

Run it with your numbersCredit plan

Two important points from the report. First, the lender reports both on-time payments and payments 30 or more days late: if you fall behind, you can hurt your score. Second, if you stop paying, the loan is closed: you are not left owing a balance, but you do get a negative mark on your history.³

Before you sign, ask the lender these questions. The answers vary from place to place:³

• How much is the loan and how many months does it last?
• What is the APR, and how much will I pay in total, with interest and fees?⁴
• Do you report my payments to Experian, Equifax and TransUnion?³
• Do I get the money after each payment or all at the end?³
• How much do you charge if I am late, and do you charge anything if I pay early?⁴

When you finish, the money you saved is yours. The CFPB says more research is needed on whether people withdraw that money or keep saving it.³ If you can leave it in place, it can be the start of your emergency fund.

What the CFPB found: who it helps most

The CFPB funded a study of a credit union’s credit-builder loan. The loan worked better for people without existing debt: among them, opening it increased the likelihood of having a credit scorecredit scoreA credit score is a number that predicts how likely you are to pay back a loan on time. It is computed from the information in your credit report: whether you pay on time, how much you owe relative to your limits, how long you have used credit and how many new accounts you opened. FICO is one brand of score; VantageScore is another, and each lender decides which one it uses. A higher score usually brings a lower interest rate and more loan options; each program publishes the minimum it accepts. You can check your report for free and dispute errors.See the full definitionClose by 24%. For people who already had debt, though, it lowered scores slightly, on average.³

It also found that 39% of the people who opened the loan made at least one late payment, and that the loan was associated with more late payments on other loans. The savings results were less conclusive.³

That is why the CFPB says people with no score or no debt may benefit most. People who already have debt may want to consider paying down other loans before opening one, or choosing other products and services to build credit, such as credit education or counseling.³

The costs to check

This loan is not free. According to the CFPB, fees and interest vary, and risk is a key factor in setting them; on the study’s loan, they came to about $4 a month. Each lender structures its terms and fees its own way.³

So compare offers in writing. Under Regulation Z, before you sign the lender must give you, among other things:⁴

• The finance charge: the dollar amount the credit will cost you.
• The APRannual percentage rate (APR)The annual percentage rate (APR) is a broader measure of the cost of borrowing money than the interest rate. Besides the interest, it includes certain loan charges, such as discount points and some lender fees, spread over the life of the loan and expressed as a yearly percentage. That is why the APR is almost always a little higher than the interest rate. It is useful for comparing offers: if two loans have the same interest rate but a different APR, the one with the higher APR charges more in fees.See the full definitionClose: the cost of your credit as a yearly rate.
• The total of payments: what you will have paid when you finish.
• Whether you can be charged for paying early and what a late paymentlate feeA late fee is what you are charged when your payment arrives after the due date or after the grace period your contract allows. Your contract says how much it is and when it applies. On a mortgage, the Loan Estimate and the Closing Disclosure show the fee and how many days late a payment must be to trigger it, and your monthly statement shows the amount and the date it will be charged if you do not pay. For rent, some states set rules: in New York, for example, the law says when a payment counts as late and caps the fee.See the full definitionClose costs.

If the loan is from a federal credit union, there is a cap: it cannot charge more than 15% a year on the balance, including all finance charges, unless the NCUA Board sets a higher cap; the Board reviews it at least every 18 months.⁵ And according to NCUA, at a credit union you can pay off your loan early without a penalty.⁷

Where to find one: credit unions, banks and CDFIs

The CFPB suggests asking your bank, your credit union or a local nonprofit credit counseling agency.¹ We do not recommend any particular institution: these are the kinds that exist.

Credit unions. According to NCUA, they are not-for-profit institutions owned by their members. They lend to their members,⁵ so you first need to join, and you may be able to join through your employer, your family (most let members’ families join), where you live, work, worship or go to school, or a group such as your place of worship, school or labor union. On average, they offer lower loan rates.⁶

CDFIs. CDFIsCommunity Development Financial Institution (CDFI)A CDFI (Community Development Financial Institution) is an organization whose primary mission is community development. It provides loans, investments and other financial services in low-income communities and to people who lack access to financing. It can be a community development bank or credit union, or a loan fund that is not a bank. The law requires that it not be a government agency, that it be accountable to the community it serves and that it offer services such as financial and credit counseling along with its loans. The Treasury Department's CDFI Fund certifies them.See the full definitionClose (community development financial institutions) are specialized organizations that provide financial services in low-income communities and to people who lack access to financing. They include community development banks and credit unions and loan funds. There are certified CDFIs in all 50 states, the District of Columbia, Guam and Puerto Rico, and the CDFI Fund publishes the list.⁹

If you have an ITINITIN (Individual Taxpayer Identification Number)An ITIN is a nine-digit number the IRS, the federal tax agency, issues to people who need a U.S. taxpayer identification number to file taxes and are not eligible for a Social Security number. It is for tax purposes only: it does not authorize you to work in the United States, does not qualify you for Social Security benefits or the Earned Income Tax Credit, and says nothing about your immigration status. You apply with Form W-7, and it expires if it goes unused for several years. Some lenders accept an ITIN for a mortgage.See the full definitionClose. In a 2003 legal opinion, NCUA saw no legal impediment to a federal credit union lending to members who use an ITIN or a matrícula consularconsular ID cardA Matricula Consular is an official Mexican government ID document issued by Mexico's consulates in the United States. Other countries offer similar IDs, sometimes called consular identification (CID) cards. According to the CFPB, many banks require a U.S. or state government-issued photo ID; if you do not have one, some banks and credit unions accept foreign passports and consular IDs such as the Matricula, but not all, and the CFPB suggests asking first. You usually also need another document, such as a bill with your name and address, and an interest-bearing account requires an SSN or ITIN.See the full definitionClose instead of a Social Security number, if it manages the risks. It also said it knows of no law that bars reporting payments under a number other than a Social Security number.⁸ Legal does not mean every credit union offers it: ask. The guide open a bank account without a Social Security number explains how to start.

How to apply, step by step

1. 1. Check where you are starting

   Before you apply

   Checking your own reports does not affect your score.¹¹

2. 2. Find where to apply

   The first week

   Ask your bank, a credit union or a nonprofit credit counseling agency.¹

3. 3. Join, if it is a credit union

   Before the loan

   You may be able to join through your employer, your family, your area or a group.⁶

4. 4. Compare offers in writing

   Before you sign

   Look at the APR, the finance charge, the total of payments and whether it reports to all three bureaus.⁴

5. 5. Pay on time, every month

   For the whole term

   Use automatic payments or reminders: payment history weighs most in your score.¹⁰

   Try it with your numbersFamily budget

6. 6. Receive your savings

   At the end, or after each payment

   Decide what to do with that money; it can be the start of your emergency fund.³

   Try it with your numbersDown payment savings plan

Credit-builder loan or secured card

Both help you get started, and they work differently.¹⁰

The two starter tools, side by side

Pay first, receive later

Credit-builder loan

• You spend nothing: you make fixed payments and the money is held as savings.¹
• It is reported as an installment loan.³
• If you stop paying, it is closed with a negative mark and no balance owed.³

Deposit first, spend later

Secured card

• You put down a deposit, for example $500, and can spend up to that amount.¹
• When you pay the bill, you get your spending room back.¹
• What weighs most in your score is paying on time.¹⁰

The CFPB lists both as starter products; choose the one you can pay on time every month.¹⁰

The secured credit cards guide covers their costs and how to use one, and what moves your credit score explains what weighs most.

If this is you

You have no credit history

In the CFPB study, for people without debt the loan increased the likelihood of having a score by 24%.³

You have an ITIN

NCUA saw no legal impediment to a federal credit union lending with an ITIN.⁸ Ask whether they report your payments to the bureaus.

You are paid in cash

You may be able to join a credit union through your job, your family or your area,⁶ and an automatic payment from your account helps you stay on time.¹⁰

You already have debts that are hard to pay

The CFPB suggests considering paying down other loans first, or looking into credit counseling.³

A HUD-approved housing counselorHUD-approved housing counselorA HUD-approved housing counselor works at an agency HUD has approved to provide housing counseling: independent, expert advice customized to your situation about buying a home, renting, a missed mortgage payment, a foreclosure or credit problems. The agencies usually charge little or nothing; many serve in Spanish and offer the homebuyer education course several assistance programs require. They are not lenders or real estate agents and sell you nothing. Your county page lists the official agencies with phone numbers.See the full definitionClose also advises on credit issues, often for free or at low cost.¹²

Common mistakes

• Mistake: Thinking you will get the money when you sign.

  Instead: You pay first; the money is held in a locked account and you get it later.³

• Mistake: Signing without looking at the APR and the total of payments.

  Instead: Ask for them in writing and compare them across offers.⁴

• Mistake: Falling behind because it is “just to build credit.”

  Instead: Payments 30 or more days late are reported and can hurt your score.³

• Mistake: Opening one when you already struggle to pay your debts.

  Instead: The CFPB found it can lower your score in that case; consider paying down other debts first.³

• Mistake: Using a payday loan to build credit.

  Instead: Those payments are not reported to the nationwide bureaus: they do not build history.¹

• Mistake: Applying for several loans at the same time.

  Instead: Each application can be a hard inquiry; apply only for credit you need.¹¹

If someone offers to “fix” your credit for an upfront payment, read the credit repair scams guide first.

What to do this week

1. Check your credit reports; it does not affect your score. The guide how to read your credit report helps.¹¹
2. List one or two credit unions or CDFIs you could join.⁶⁹
3. Ask about their credit-builder loan: amount, term, APR, fees and whether they report to all three bureaus.⁴
4. Before you sign, make sure the payment fits your budget with the family budget tool.³
5. Set up an automatic payment or a reminder for every month.¹⁰
6. If you want help with your plan, a HUD-approved housing counselor advises on credit, often for free or at low cost.¹²