Basic credit builder loans (CBLs) create short-term savings. Simply put, consumers agree to make monthly payments into a locked savings account to reap credit benefits, then get their money back as savings after paying off the loan.

By requiring the borrower make installment payments into a collateral account, CBLs create a kind of "fake" obligation to save. It's a psychological tool borrowers use to hold themselves accountable, rather than rely on self-discipline and setting aside money on their own.

However, CBLs also save borrowers money on future debt interest by building thick credit that future lenders reward with lower interest. These future savings can amount to 100s of $1,000s over a lifetime.

There is a cost. The price of saving with a CBL is interest on the loan. With the right lender, this cost is lower than present and future savings, especially for borrowers whose spending habits hinder their ability to set aside money.

Summary

How it Works

In the most basic sense, the borrower makes installment payments into a collateral account and recovers the principal value (i.e payments less interest) at the end of the loan. The principal amount recovered represents savings that the borrower built over the course of the loan.

This is how the most common kind of credit builder (called "payment-secured") works.

Only Secured CBLs Build Savings

There are three types, but only payment-secured CBLs (PSCBLs) require installment payments into a secured account. Those payments accumulate over time and contain the principal and interest portions of the loan. The lender subtracts the interest from the total loan balance as payment before returning the principal to the borrower after the loan is closed.

Another way to think about this structure is that the borrower sets aside money in the same way they would into a dedicated savings account, with a portion paid to have the account.

The other two CBL types lack the necessary payment structure to build savings. Fully-secured CBLs require the a deposit of the full loan amount upfront, so the borrower must have the savings before obtaining the loan.

Unsecured CBLs function like traditional loans and distribute loan proceeds upfront. The borrower's payments pay back the principal plus interest and do not become savings.

Example

Imagine you want to get a mortgage but the interest is too high because of your credit. You're approved for Digital Federal Credit Union's credit builder for $1,750 at 5% interest over 12 months.

Each month, you pay $149.81 into a savings account that you cannot touch for a total of $1,797.76 after 1 year.

Digital Federal then gives you back $1,750 and keeps $47.76. You have now saved $1,750 and improved your credit.

You apply to the mortgage again and get quoted a low interest rate... with $1,750 available to put towards a down payment.

Prudent Savers Benefit Too

PSCBLs help consumers who struggle to save, but they also help consumers with cash reserves put their money to work building credit.

Frugal consumers can simply change the account where they put their money from a classic savings account to a CBL account.

This dynamic is why fully-secured CBLs are considered low-effort tools. It's as simple as making a "payment" to a credit builder, which becomes savings.

Psychology of Saving with a Credit Builder Loan

There is a sense of accountability in fixed payments that pushes spenders to commit psychologically to the savings process through CBLs. Our discussions with consumers reveal that many are stuck in the poverty and payday loan cycle because of the difficulty of not spending money.

There are social pressures and outright temptation. Many become frustrated by promising themselves not to spend, only to change their mind at the store.

CBLs provide accountability for this scenario because the sensation of impending payments that will hurt your credit if unpaid provide an extra muscle to say no in the face of temptation.

How Much Savings PSCBLs Provide

The average savings borrowers build with credit builder loans is $3,283, with a range of $100 to $100,000¹. These figures represent the average principal amount on CBLs because the principal is what borrowers pay into savings.

The assumption here is that the borrower pays the loan in full according to the complete payment schedule. Early payoff and cancellation limits the amount you can save.

Limitations to Saving: Early Payoff & Cancellation

Borrowers can almost always payoff their CBL early, and at least 10% of CBLs allow penalty-free cancellation¹.

It's important to note that canceling a credit builder not only stops the benefits it has on credit files, but also cuts savings short.

If borrowers have sudden cash constraints and decide to terminate the loan early, their savings stop building and the lender returns the cash as it stands on the current balance.

Lenders design their loans to last long enough to maximize your chance of credit improvement, so we encourage borrowers to enjoy the flexibility of penalty-free cancellation but recognize its constraints.

Cost of Saving

The cost to saving with credit builders is interest. As borrowers make payments into the savings account, they pay principal and interest. Once the loan matures, they recover the principal portion of the loan. The lender keeps the interest as compensation for providing the CBL service.

Credit builder loans like Loqbox do not charge interest payments and instead require you open a checking account. Others require the borrower take educational courses or sign up for a membership with the lender that includes a series of services.

Borrowers should take note that membership costs are not included in APR, so a 0% APR loan with membership does not mean that there is no cost to borrowing.

How Much it Cost

The average cost of saving with a credit builder loan is $264, with a range of $20 to $2,494¹. These figures represent the total absolute interest on PSCBLs and assume the borrower pays the loan in full according to the complete payment schedule.

If the borrower cancels the CBL early, the total interest charge will be lower than the average and equivalent to accumulated interest until the date of cancellation.

Savings Payout

Savings are paid out after loan closure within 2 — 4 weeks on average, with some lenders waiting as long as 2 months.

Moreover, some lenders have garnered a reputation for flagging accounts for suspicious or fraudulent activity and blocking all transactions, including payouts. Customers have recounted instances where formal complaints they file result in a fraud flag.

The best way to prevent savings lockup is by choosing a transparent lender that operates under best practices. Good credit building plans identify these lenders so borrowers don't have to.

Building Credit Saves on Future Interest

In addition to short term savings, the positive impact payment-secured CBLs have on credit profile translates to lower interest on future loan payments.

When borrowers create thick credit files, they demonstrate reliability and consistency to lenders. Those lenders then offer lower interest rates on bigger loans like car, home, and biz loans.

Lower rates translate to $1000s in savings. Even 1% lower interest saves $106,931 in interest on a 30-year $500,000 mortgage (from 5% to 4%).

Total Savings with CBLs over Life

Altogether, the savings in account on PSCBLs today plus the savings on interest in the future outweigh an average cost of $264 for most consumers.

The positive impact of credit builder loans in saving money explains their growing popularity. But choosing the right CBL is about more than cost.

Consumers must consider factors such as three-bureau reporting, available in resident state, prioritizing cash or credit, ease of management, and more.

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