What Is a Credit Builder Loan?

What Is a Credit Builder Loan?

July 21, 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 CFPB researched the effects of up-and-coming credit builder loans and how they’re helping consumers quickly build their scores.

What Is a Credit Builder Loan (CBL)?

A credit builder loan is a line of credit specifically designed for people with no credit score or limited credit history. With a credit builder loan, 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.

CFPB Study Shows How Effective CBLs Are for Building Credit

The CFPB interviewed over 1,500 consumers who received a credit builder loan from a credit union. They found that on average, participants saw a $253 increase in their savings balance after the loan. Consumers who did not have debt before receiving the CBL saw up to a 60 point increase in their credit scores. However, many consumers with existing debt actually experienced a score decrease after getting a CBL. Around 82% of the participants had a credit score before getting the loan.

Unfortunately, 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 CBL increased the likelihood for making late payments on other types of loans.

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 CBL 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.

The information contained within this article was accurate as of July 21, 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.

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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.