Credit builder loans (CBLs) are an ideal credit solution for most borrowers, but no product is perfect. It's important consumers consider the downsides before signing.

Most disadvantages arise from poor choice of lender, poor management, and misconceptions about how they work, but concerns inherent to CBL design and uses include diminishing benefits for strong credit profiles and membership fees that don't appear in APR.

Consumers should consider the elements outlined in this article and always investigate offer details before signing on the dotted line.

Key Takeaway

Credit builder loans are effective credit building tools, but only with the right lender, amount, mix, and timing. Ignoring these elements can result in limited returns, overpaying, or worst of all, negative results.

Credit builder loans are most effective as part of professional credit improvement plans. This is particularly true for borrowers with average or above-average profiles, which require special attention and detail.

#1 Not a One-Stop-Shop

Their name suggests credit builder loans are powerful enough to improve consumer credit independently, but the reality is they are best when used as one piece of the credit puzzle.

Because they are installment debt, CBLs can only contribute 50% of the required credit mix to generate high-value credit reports and scores.

Many consider this limitation a disadvantage, but not because CBLs are themselves weak products. It's because many lenders mislead consumer to believe that they can quickly buy their way to good credit, which is not true.

Excepting rare circumstances in which consumers have large erroneous negative marks on their report that simple disputes can remove, credit building requires at least 1 month to see results.

For best results, CBLs must be used strategically with revolving credit (such as credit builder cards), with the right amount, at the right time as directed by a professional or DIY planner.

#2 Not an Overnight Solution

Credit reports and scores function like reputations. They require time to construct but can be severely damaged with a single mistake. Even something as simple as a missed payment remains on reports for 7 years.

To better understand, imagine credit like a statistical set of numbers. There is an average to which all profiles tend to move.

For example, below-average profiles more easily improve to the average with responsible credit management, and above-average profiles more easily slide back to the average.

The allure of fixing credit "overnight" is powerful, which has led to the creation of so-called "credit repair" services who dispute negative marks. Disputing is only a useful tactic in the case of legitimate errors. Missed payments, collections, and charge-offs cannot be simply removed.

Credit builder loans are not a repair tool. They are a building tool that takes more than a day or week to exert its full effect.

#3 Most Results in 1 — 6 Months

Consumers with poor credit may see results as quickly as 1 month because they regress (upward) to the mean, but most consumers should expect to see reliable results within 6 months.

One reason for this delay is a credit factor called "new credit." When borrowers apply for new debt, the lender runs a hard credit inquiry that remains on the report for 1 year.

This hard inquiry has a negative impact because lenders automatically assume new debt is risky. Consider, for example, lending money to a friend. Just the fact that s/he requests money suggests financial trouble. Lenders think the same way.

We refer to this initial drop as part of the credit building "wave," shown in the image below.

Consumers should expect the impact of "new credit" to diminish within 1/2 year because it is half the life of the hard inquiry and time dilutes the impact of everything on credit reports. In other words, 6 months is a reliable timeline to see results.

Many borrowers consider the delay a disadvantage because it does not provide fast results, but the root cause of that frustration is the United States' credit-based system, not the CBL itself.

#4 Money Arrives at the End (2 of 3 Types)

Standard credit builder loans, known as payment-secured, do not distribute loan principal up front. Instead, the lender holds the principal in a secured account until the borrower pays off the full value of the loan. The money is then distributed at the end of the loan.

This structure can be frustrating for borrowers who don't understand it beforehand. That said, it's also what allows CBLs to accept subprime borrowers at favorable interest rates, as well as create savings.

Another kind of CBL called fully-secured also distributes funds at the end of the loan, but it requires the full amount of principal be deposited on account at the start of the loan rather than progressively contributed with each installment.

#5 Present & Future Savings at a Cost

Credit builder loans create savings in two ways. First, they require the borrower deposit each installment in a savings account until the balance on that account equals the value of the principal. That money becomes a form of savings the borrower receives at the end of the loan term.

The second is by improving credit profile. Better profiles procure better interest rates because lenders feel they can trust borrowers who demonstrate responsible use of installment credit.

Those rates directly translate to cost savings on future debt (estimated at more than $110k on average).

They also help consumers find better rent deals, secure better jobs, pay lower insurance premiums, and obtain favorable terms on virtually any transaction in their financial lives.

However, CBLs come at a cost. At roughly 6% — 14% average interest range, consumers must be willing to pay now to save later. Cost can be considered a disadvantage.

#6 Less Effective on Good Credit

Credit builder loans are generally less effective as a tool to turn good credit → great credit than poor credit → good credit.

The reason is statistical. The average profile falls under the "good" credit range, and has about 5 accounts. By building up to the average, consumers with below-average profiles improve more easily than consumer who already have above-average profiles.

CBLs always help, but their effects require more time for those who already have thick, error-free profiles. This is a disadvantage for mid-tier profiles looking to grow fast.

#7 Some Lenders Have Slow Payouts

Once the consumer pays the amount of the loan in savings and fulfills other obligations, there is a delay before the money is paid out.

Contrary to personal loan lenders who compete to distribute fastest, CBL distribution occurs after the fact an usually takes two (2) weeks.

However, some lenders are unnecessarily frugal and take up to two months (8 weeks) to distribute. Consumers can avoid this frustration by screening their offers before signing.

#8 Some Lenders Check Credit Reports with a Hard Inquiry

While CBLs are known for not checking credit. Approximately 30% of lenders have zero check and another 10% run soft pulls that don't appear on credit reports.

The flip side is that about 60% of all lenders will check your credit and leave a hard pull on the report.

#9 Membership Fees Circumvent APR

Not all CBL providers charge membership fees, but those that do are not legally required to figure in annual percentage rate (APR) calculations like every other non-interest fee.

For consumers, it's important to keep this in mind when shopping. Two offers with the same APR could have a different final prices if one charges a membership fee.

#10 May Cause Initial Score Drop

A common frustration for consumers is the initial drop associated with new accounts. This is similar to the expected 6-month delay, but it's separate because some borrowers want to quickly improve their score for a large loan in a number of weeks. CBLs are not the right choice for this scenario.

That's worth repeating. CBLs are not a good choice for lenders who want a boost before taking out a large auto or home loan within 1 - 2 weeks.

The reason is that using a CBL can have the opposite effect, as shown in the credit building wave image below (same as above). New accounts cause an initial drop because lenders consider new debt inherently risky.

This is actually a reason why we recommend consumers lean on professional advice or guided DIY. Managing expectations and timing the acquisition of accounts is critical to reaching financial goals.

#11 Missing a Payment Hurts Your Profile

There is a misconception about the risk-less nature of credit builder loans.

While they have guardrails built-in, penalty-free cancellation, and are structured to prevent errors, CBLs are loans like any other.

Missing a payment will have decidedly negative impact on the borrower's credit profile.

#12 Beware Misleading Offers

Unfortunately, some lenders hide unnecessarily severe conditions that mismatch with the beneficial spirit of credit builder loans.

Some lenders charge high interest, hide fees in membership schemes, or falsely market normal loans as CBLs in order to encourage applications. Consumers should keep these items in mind when shopping.

Remember: Bad Offers are Everywhere

Most of the disadvantages of credit builder loans are the result of misconceptions, poor expectations, and bad offers. Bad offers are part of any financial market, from auto & mortgage loans to credit cards and personal loans.

Finding the right CBL from a trustworthy lender is the best way to avoid frustration, stress, and potential credit issues. Used correctly, CBLs offer many benefits within a tool for improving one's score, reports, and overall profile.