Do Credit Builder Accounts Work?

Do Credit Builder Accounts Work?

November 10, 2020         Written By Heaven Speirs

According to the Consumer Financial Protection Bureau (CFPB), approximately 26 million American adults do not have a credit score. The problem many of these Americans find themselves in is that it ‘takes credit to build credit.’ Getting a loan or credit card without a credit score can be challenging, but it is not impossible.

The solution lies in the credit builder accounts, which, as their name suggests, help customers build credit. Let’s take a look at how credit builder accounts work and how effective they are at boosting credit scores.

What Is a Credit Builder Account?

A credit builder account, also known as a credit builder loan or CBL, is a line of credit specifically designed for people with no credit score or limited credit history. With a credit builder account, borrowers are required to make a payment before any money is released. The loan terms usually last between 6 and 24 months. Once the borrower makes a payment, the lender releases part of the loan into his or her savings account. Some lenders wait until the loan is paid in full before releasing the funds.

At that point, why not just save the money? Because the CBL payments are reported to the credit bureaus. You are essentially saving money each month, but the extra step of making a loan payment allows you to build credit for the savings. The lender is not out any money because they are getting paid before disbursing funds. Thus, they have no risk in approving someone with limited or no credit for a loan.

Featured Credit Builder Account: Credit Strong Credit Builder Account

  • Build credit and grow your savings every month
  • No security deposit required to open the account
  • No credit check – all credit scores accepted!
  • Monthly payments are reported to all three major credit bureaus
  • When the loan is repaid, your savings unlock
  • Get a free monthly FICO Score each month to track your progress
  • Cancel at any time for no additional costs

Do Credit Builder Accounts Work to Build Credit?

Yes, a credit builder account can improve your credit score if you make your payments on time. Payment history is the most significant factor in your FICO credit score, representing 35% of the overall score. Make your payments on time each month, and you’ll see a steady increase over time.

The CFPB interviewed over 1,500 consumers who received a credit builder loan from a credit union. Consumers who did not have debt before receiving the CBL saw up to a 60-point increase in their credit scores. With this in mind, many consumers with existing debt actually experienced a score decrease after getting a CBL. The decline was only 3 points on average, but this indicates existing debtors either failed to make their CBL payments or fell behind with their other debts. Around 82% of the participants had a credit score before getting the loan.

To maximize the effects of the credit builder account, make all of your monthly payments on time. Keep up with your other debt payments as well, and avoid new debt until the CBL is repaid.

How a Credit Builder Loan Could Boost Your Personal Savings

Credit builder accounts can do more than just build credit. They can also improve your personal savings. The lender will deposit money into your savings account, corresponding to the loan payment. You could transfer that to your checking account, or you could use it as an opportunity to build a savings account. If you’re a person who struggles to save but reliably pays your bills, this turns your savings into a bill! You can continue saving the same amount after the CBL term is over.

The CFPB reported an average savings increase of $253 for credit builder accountholders. This was strongest among consumers who had pre-existing debt. Those borrowers saved an average of $347. By comparison, CBL recipients without other debt only saved $4 after the loan. The authors of the study noted that these findings “may reflect in part shifting balances between different accounts rather than a net increase in savings.” Nevertheless, if you follow the practice mentioned above, you can jumpstart your savings regardless of your debt status.

Can a Credit Builder Account Hurt My Credit Score?

Much like any other loan, a credit builder loan can negatively impact your credit score if you miss payments. It can also hurt your score if having a credit builder account causes you to miss payments on other loans or credit cards. The CFPB found that 39% of CBL borrowers made at least one late payment on their loan. This includes 36% of borrowers with other debts and 45% of borrowers without existing debt. Furthermore, having a credit builder account increased the likelihood for making late payments on other types of loans.

Don’t let this information discourage you from getting a credit builder loan. Instead, use it as a reminder of how important loan payments are. Do not pursue a CBL if it is going to jeopardize your other lines of credit. You can re-evaluate opening a credit builder account when you have more income to spare.

Who Benefits Most from Credit Builder Accounts?

The CFPB’s findings indicate that credit builder loans do have the potential to increase savings balances and credit scores for adults without a credit score. They are much less effective for borrowers with a credit score and existing debt. This may be a struggle with managing multiple loans, or it could have to do with the way CBLs compare to other loan products.

With this in mind, you could benefit from having a credit builder account if you are diligent with your payments, just like any other loan. Make your payments on time each month, and do not apply for a credit builder loan if you cannot afford it at this time. Focus on paying off your other debts first. Then decide if a CBL is right for you.

Another Credit Building Alternative: Secured Credit Cards

Credit builder loans aren’t the only opportunity to build credit with no credit score. Secured credit cards have a longstanding reputation of helping consumers establish credit at little-to-no risk for the lender. Here’s how a secured credit card works:

  1. Find a secured credit card with features to match your needs. Be sure to review the annual fee, APR, monthly fee, deposit limits, and other factors.
  2. Apply for the secured credit card of your choice. Most card companies will not evaluate your score or credit report for this type of card because they are not providing any money out of pocket. Approval is mostly guaranteed.
  3. Deposit an amount of money into your secured card account. This becomes your credit limit. Deposit amounts vary, but most cards support deposits between $200 and $3,000.
  4. Receive your card in the mail and use it like a credit card. You can pay bills, shop online/in-person, dine out, and do anything else you want with your secured credit card.
  5. Make at least your minimum monthly payments on time each month. Ideally, you should pay off your balance in full. This isn’t like a prepaid card where the balance drops without consequence. You must repay it to get a positive payment reported to the credit bureaus.
  6. The secured card provider will report your payment history to the credit bureaus. This includes positive and negative payment histories, which is why it’s important to pay on time.

If you decide to cancel your secured card, you will receive a refund for your deposit, minus any applicable fees and any charges you’ve made to the account. If you want to increase your credit card limit, you may be able to deposit additional funds onto the card. Some secured cards offer unsecured credit line increases after a certain amount of time. This money does not come out of your pocket, but it will not be refunded to you if you cancel the card.

Should I Open a Credit Builder Account or Secured Credit Card?

Secured credit cards and credit builder loans serve similar purposes, but they are structured quite differently. With a credit builder account, you do not have to pay a large sum upfront. You make small monthly payments and receive corresponding funds into your savings account.

With a secured credit card, you provide the entire deposit upfront and repay your transactions each month. You do not get the deposit back until you cancel your card. The deposit is entirely refundable, minus fees and outstanding charges, but the money is not freely available while the card is open. You must pay it back if you use it, forcing you to maintain a savings of sorts on the card.

A credit builder account could help you increase your personal savings if you do not touch the money deposited back into your account. However, a secured card ensures that you do not touch the money, thereby giving you a better chance at maintaining your savings. CBLs turn savings into a bill, but secured cards establish good credit card habits that you could use for future cards.

Yet another factor to keep in mind is that a credit builder loan could lead to additional loan opportunities. A secured credit card could lead to better credit card opportunities, such as a cash back credit card or travel rewards card. A higher credit score will improve your access to lines of credit in general, but you could get an extra leg-up by selecting a specific product.

Think about the goals you have for building credit and what you can financially contribute to the process. If you do not have enough to make a secured card deposit, you may be better off with a credit builder account. If you want to turn your savings into a credit building platform, a secured credit card could be perfect for you. No matter what you decide, make sure you maintain your monthly payments to boost your credit score.

The information contained within this article was accurate as of November 10, 2020. For up-to-date information on any of the terms, cards or offers mentioned above, visit the issuer's website. Many of the offers on this article are from our affiliate partners, and LowCards.com may be compensated if you take action with any of our affiliate partners.

Review LowCards.com Editor’s Top Cards!

2020 Top Credit Cards by Category
Featured Prepaid Card
NetSpend® Visa® Prepaid Card
EDITOR RATING
Featured Prepaid Card
NetSpend® Visa® Prepaid Card

Applying for this card will securely direct you to the issuer's website.

Top Features: No late fees or interest charges because this is not a credit card it is a prepaid card. 

Featured Secured Card
Assent Platinum 0% Intro Rate Mastercard Secured Credit Card
EDITOR RATING
Featured Secured Card
Assent Platinum 0% Intro Rate Mastercard Secured Credit Card

Applying for this card will securely direct you to the issuer's website.

Top Features: Intro APR Offer on Purchases

Featured Fair Credit Card
Reflex Mastercard® Credit Card
EDITOR RATING
Featured Fair Credit Card
Reflex Mastercard® Credit Card

Applying for this card will securely direct you to the issuer's website.

Top Features: All credit types welcome to apply!

Featured Bad Credit Card
First Digital NextGen Mastercard® Credit Card
EDITOR RATING
Featured Bad Credit Card
First Digital NextGen Mastercard® Credit Card

Applying for this card will securely direct you to the issuer's website.

Top Features: Reports to all three credit bureaus, perfect credit not required for approval


heaven

About Heaven Speirs

Heaven Speirs is a contributing writer for LowCards.com. She remains up-to-date with the latest developments in the credit card industry and the financial sector as a whole. Heaven has over 10 years of experience in online journalism, the bulk of which has been focused on personal finance. Heaven attended Oklahoma State University, where she discovered her talent for research and content creation. In her spare time, Heaven enjoys painting, playing poker, and spending time with her husband and three dogs.