Key learning points
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A credit-building loan can help borrowers start their credit journey on a positive note or improve their score.
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To choose the right credit-building loan for your needs, consider how the monthly costs fit into your overall budget.
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When comparing options, consider your preferred method of communication, as some lenders only offer online support.
Although taking out a loan to improve your credit score may feel counterintuitive, it can be a practical approach as long as you use the loan responsibly. A credit-building loan is intended to help borrowers who need to build or improve credit from the start.
After your application and approval, your loan balance is often credited to a savings account. By successfully making fixed payments, you build your credit and savings at the same time. When considering which option best suits your needs, it is essential to pay attention to certain factors, similar to purchasing a traditional personal loan. Also assess where it makes sense to find the best credit-building loans for your situation.
6 Factors to Consider When Choosing the Best Credit-Building Loan
When comparing options, consider the following factors to find the best credit builder loans.
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Although these types of loans are intended to build your credit, there are costs associated with that building. The annual percentage rate (APR) tends to fall between 5 percent and 36 percent, with credit unions often offering lower APRs. The higher the interest rate, the more you have to pay monthly.
Bank interest tip
Use a personal loan calculator to ensure you can keep making the payments.
Cost
The costs of applying for and maintaining your loan vary by lender. These small costs may be the cause of the loan application, administration or payment arrears.
It’s best to sign up for automatic payments to avoid incurring fees for missing payments. If you’re working on a tight budget, shopping with lenders that advertise minimal or no fees makes sense.
Loan terms
The loan terms are the period in which you must pay off your credit-building loan. In the case of these types of loans, borrowers can expect repayment terms of six to 24 months, but some also offer terms of up to 48 months.
The longer you extend the term of your loan, the lower your monthly payment will be. Credit-building loans have a shorter term because small amounts are intended to be paid off quickly.
Additional features
When comparing options with similar rates, research how the special features offered can sweeten the deal. If you want consistent updates, look for a lender that shares FICO score changes. Also look for lenders that report to all three credit bureaus, as the primary goal is to build your credit score. Other features lenders can offer include deferred payments to help those on a tight budget.
Customer service
Credit-building loans can be found from a variety of sources, including brick-and-mortar banks or online lenders. When determining which resource best suits your needs, consider your business preference. If you’re confident in your ability to navigate your finances online, an online lender is a good option. If you prefer additional, tailored assistance, consider consulting a bank or credit union with offices near you.
Reputation
Smaller banks and credit unions can offer credit-building loans. Just because they are less prominent institutions doesn’t mean they aren’t trustworthy. However, not all lenders on the market are reliable.
Check online reviews and the Better Business Bureau to ensure you aren’t sharing financial information with a high-risk source. Doing extra research and finding actual customer testimonials on a third-party review site can help you borrow with more confidence.
Where to find credit building loans
You can find credit-building loans in several places:
Banks: Community banks can be a good place to secure a loan if you like the personal customer service and local offices that these branches typically offer. However, they usually cost more.
Credit unions: Credit unions often have local offices and personal customer service. However, credit unions may bring additional benefits, such as reduced account fees or lower interest rates on loans. Credit unions operate as nonprofits and typically have lower overhead costs than banks, which often translates into more affordable services for consumers.
Online lenders: Online lenders may offer some of the best loans for credit building. The lack of physical overhead can translate into more competitive rates. Choose this option if you are mainly concerned about the convenience of doing everything online and faster processing, from application to payment. However, with online lenders, you will need to do more background research through sources like the BBB to ensure they are legitimate lenders since you cannot see them in person.
Credit circles: This is an alternative option. These groups contribute a fixed amount to a shared pool. Then, each member of the group receives money on a rotating schedule. This method can avoid interest and fees. Look for credit circles run by reputable nonprofits and institutions that can report to the credit bureaus to help you build credit.
Next steps
The purpose of a credit building loan is just that: build your credit. To gain the financial strength that a good credit score brings, you need to get a loan that you can afford and that you pay off on time. When shopping, pay close attention to your monthly payment and specific needs.
