What is a credit-builder loan?

Back to financial education | Credit & debt

November 9, 2024

5 min read

If you’re looking to build or improve your credit score, a credit-builder loan might be just the tool you need. Unlike traditional loans, which provide you with a lump sum upfront, a credit-builder loan works differently, focusing on helping you establish or repair your credit history. Whether you’re new to credit or recovering from past financial missteps, understanding how credit-builder loans work can be a crucial step toward achieving your financial goals.

Here’s what we’re going to cover:

How do credit-builder loans work?
How a credit-builder loan can improve your credit
Where can I get a credit-builder loan?
Is a credit-builder loan right for me?
Alternative options for improving your credit-builder loan
Oportun: affordable lending options designed with you in mind

Key takeaways

credit-builder loans help establish or improve credit scores. Special financial products are designed to minimize the risk to the lender, plus encourage on-time and in-full payments.
Timely payments positively impact your credit score by improving your payment history and adding to your credit mix.
Credit-builder loans are available from credit unions, community banks, online lenders, and lending circles.
An application requires proof of identity and identification number like a Social Security Number, income, banking info, and address verification.

How do credit-builder loans work?

A credit-builder loan is specifically designed to help individuals build or improve their credit scores, while also reducing the lender’s risk that a borrower won’t repay the loan. For example, one credit-building loan is structured so that the lender deposits the loan funds into an inaccessible account until it’s repaid. The lender doesn’t give you the money upfront, rather it has to be earned with responsible payments which include both the principal and interest. Payments are reported to the credit bureaus. Upon full repayment, the borrower receives the loan funds plus any accrued interest, making it a forced savings tool as well. When repaid according to the plan, this process demonstrates to creditors responsible use of credit and can positively impact your credit score.

How a credit-builder loan can improve your credit

Payment history is a significant factor in calculating your credit score and makes up 35% of your score, according to the FICO credit system. These products encourage on-time and in-full payments.

Having a credit-builder loan on your credit report also adds to your credit mix—the different types of credit accounts you have, like loans and credit cards—which can boost your score. Over time, these improvements can make you eligible for better terms for financial products you apply for.

Where can I get a credit-builder loan?

Several types of financial institutions offer credit-builder loans. Here’s where you can find one:

Credit unions

Credit unions often provide credit-builder loans to their members. These not-for-profit organizations usually offer lower interest rates and more personalized services compared to traditional banks.

Community banks

Local community banks may offer credit-builder loans as part of their commitment to supporting the financial well-being of their communities. These banks might also provide personalized service and competitive rates.

Online lenders

Online lenders can be a convenient option, often offering quick application processes and the ability to manage your loan entirely online. Some online lenders specialize in credit-builder loans, providing tailored services to help you achieve your credit goals.

Lending circles

Lending circles are community-based groups where members lend money to each other. These informal loans can help build credit if the lending circle reports your payments to the credit bureaus.

What you’ll need to apply for a credit-builder loan

To apply for a credit-builder loan, you’ll typically need to provide:

Proof of identity (such as driver’s license or passport)
Social Security number or Individual Taxpayer Identification Number (ITIN)
Proof of income (such as pay stubs or tax returns)
Information about your checking and savings accounts
Address verification (such as a utility bill or ID)

Is a credit-builder loan right for me?

A credit-builder loan can be an excellent choice if you’re looking to establish or improve your credit history. It’s especially beneficial if you’re credit invisible, which means having no credit history at the three credit reporting agencies. Additionally, this type of loan requires disciplined payments, which can be a valuable learning experience in managing debt.

Alternative options for improving your credit score

If a credit-builder loan doesn’t seem like the right fit, you might consider these alternative options to improve your credit score:

Unsecured personal loan

An unsecured personal loan doesn’t require collateral—an asset you own, like a house or car, to secure the loan—and can be used to build positive credit if you make regular timely payments.

Secured personal loan

A secured personal loan requires collateral, which can help you qualify for better terms. Like a credit-builder loan, making timely payments on a secured personal loan can improve your credit score.

Secured credit card

A secured credit card requires a cash deposit that serves as your credit limit. Using the card responsibly and paying your bill on time each month can help build your credit history.

Become an authorized user

You can ask a family member or friend to add you as an authorized user on their credit card. This allows you to benefit from their positive credit history without being responsible for the debt. This comes with the expectation of trust that you will use your family member’s credit card responsibly.

Oportun: Affordable lending options designed with you in mind

A loan through Oportun can help you build positive credit if you make regular on-time and full payments while repaying the loan. Our loans are designed so payments fit within your monthly budget, and loan payment days are often aligned to payday from your job. However, our loans don’t come with other guardrails that are often associated with credit-builder loans.

Now that you understand how credit-builder loans work, you can learn about how Oportun may be able to help you if you’re looking for affordable credit options. Visit our homepage to learn about: