Published: 25 July 2023
Updated: 27 January 2024
Author: Noah G.
Credit builder loans (CBLs), or credit-builders, are personal loans that help consumers with little or no credit improve their score by applying a combination of flexible eligibility criteria and deferred principal distribution. Lenders include banks, credit unions, and online lenders at an average principal of $3,283 and APR of 7.78%.
CBLs are not the same as consolidation loans, whose purpose is to help payoff one or more financial obligations with a single installment loan. They're also not the same as credit builder cards, which use revolving lines to thicken credit reports.
Credit builder loans exist in three types and are usually secured. The lender, or creditor, requires the borrower make payments over the duration of the loan. The lender holds these payments as collateral, usually in a savings account or certificate of deposit, for the duration of the loan. Once matured, the bank disburses the principal amount of the loan and keep the interest.
Unsecured credit builder loans do not require collateral, but still provide flexible eligibility criteria. They are handled by lenders with expertise in subprime creditworthiness because traditional banks typically deny subprime credit by default.
Because subprime lenders assume more risk, the terms and conditions of unsecured credit builder include higher interest rates and stricter payment schedules than normal loans or secured credit-builders.
When the borrower makes payments towards the loan, the lender reports positive payment history to credit bureaus such as TransUnion, Equifax, and Experian. These reports improve the borrower's credit history.
Credit builder loans originated before the financial crisis in 2008 and began to appear prominently in 2011. Over ten years they've grown from a niche startup product to a prominent tool offered by credit unions and regional banks, but there has been a lack of research and analysis due to their classification as secured loans.
This page is the first comprehensive account of credit builder loans in the market. It is the product of over 100 hours of research and the collection of over 5,500 data points in the field from lenders, borrowers, and extractions from studies by the Consumer Financial Protection Bureau (CFPB) and The National Bureau of Economic Research (NBER), as well as the NCUA.¹²³
Credit builder loans are personal loans that use a combination of cash collateral and alternative creditworthiness to provide installment debt to consumers whose limited, zero, or damaged credit history makes normal loans inaccessible or unaffordable.
Let's take Cheese's $500 credit builder at 10% interest over 12 months as an example. You pay $43.96 / month for 1 year, then Cheese gives you back $500 and keeps $27.50. You essentially pay $28 to improve your credit, which in turn saves $1000s on future loans.
Other popular online providers include Self, CreditStrong, MoneyLion, and Kovo.
Several banks offer credit-builders such as Republic Bank and Sunrise Bank.
Credit unions are also ideal providers because of their non-profit nature and focus on the community. Popular credit union providers include Digital Federal (DCU), Alltru, Metro Credit Union, and Southwest Financial. Community Development Financial Institutions (CDFI) are also good providers like CommunityWorks.
The above examples focus on secured credit-builders. Some providers with a tolerance for low credit provide unsecured credit builder loans such as Prosper, Upgrade, and Upstart.
The credit building paradox is a catch-22 situation in which consumers need credit to improve credit, but must improve credit before getting it. Credit Builder Loans function as a tool to establish diverse credit quickly and affordably.
Credit builder loans use two structures to help borrowers build credit. The first is a secured structure in which the borrower makes fixed payments over the life of the loan and the lender distributes the principal amount at maturity, retaining interest.
For example, imagine a consumer takes out a $1,000 credit builder loan over 12 months at 5% interest and makes 12 payments of $85.61 for a total of $1,027.29.
At the end of the loan, the lender returns $1,000 to the borrower and keeps the remaining $27.29 in interest. This differs from a standard personal loan, which distributes the principal at the beginning of the loan schedule.
The second structure is unsecured. Using the example above, the lender distributes $1,000 at the start of month 1. The borrower makes the same $85.61 installments over twelve months, which include the principal and $27.29 interest.
This is the same structure as a traditional loan. The difference between unsecured CBLs and traditional loans lives in the terms. Lenders offering unsecured credit-builders usually charge higher interest and have more rigid payment schedules than traditional lenders to compensate for the elevated risk of borrower default.
CBLs work because they use a combination of techniques that normal loans avoid. These include savings-based collateral and alternative creditworthiness metrics to provide flexible eligibility criteria to subprime borrowers.
Credit builders loans establish positive payment history and credit mix on consumer credit reports by reporting as normal personal loans. Credit bureaus and lenders read them like any other loan.
Unlike traditional loans, however, secured credit builder loans help build savings and often provide interest on the deposit. They also provide the flexibility of canceling any time without paying the loan in full and still reporting as "closed—paid as agreed" to TransUnion, Equifax, and Experian.
Many consumers completing debt payoff plans and hardship plans turn to credit builders because of this flexibility.
The average amount of credit builder loans is about $3,200 and the average limit, or maximum amount offered, is about $5,700. Amounts range from $500 to $50,000 and depend on duration and interest.
A common option for consumers with no history is $500 paid over 12 months. More advanced options for consumers with significant derogatory marks on the credit report include $1,000 to $5,000 over 24 to 60 months. In some cases consumers with high income but low credit choose $50,000 paid over 36 - 84 months.
Ultimately the amount of a CBLs depends on the borrower's needs, debt-to-income ratio (DTI), and other factors such as use of secured credit cards.
All loans are a type of debt. They share a number properties such as principal amount, currency type, grace periods, repayment schedules, duration and payment terms, a loan contract usually called a promissory note, the presence or absence of collateral, interest rate, and renegotiations.
Credit builder loans differ from other loans because their purpose is to improve credit history rather than finance the purchase of assets. This difference manifests in the properties of the loan.
Mortgage loans have higher principal amounts and longer durations than credit-builders, as well as lower interest rates. They also use houses as collateral and have easier renegotiation terms compared to credit-builders. Mortgage loans and credit-builders use the same standard schedule interest rate that accrues during each period and compounds when unpaid.
Personal loans can serve the same purpose as credit-builder. When they do, the two are synonymous. Generally, however, personal loans are used to fund a defined expense or asset rather than build credit. They have lower interest rates, higher principal amounts, and longer durations. They more commonly have grace periods and renegotiation terms as well. Personal loans and credit-builders use the same standard schedule interest rate that accrues during each period and compounds when unpaid.
Commercial loans serve businesses, whereas credit-builders serve consumers. Some credit-builders serve businesses but only single-member LLCs or other pass-through entities in which the owner's credit initially doubles as the business' credit. Commercial loans have higher principal values and longer durations. Commercial loans also have more flexible payments schedules and renegotiation terms. Commercial loans and credit-builders use the same standard schedule interest that accrues during the period and compounds when unpaid.
Secured credit-builders have the added benefit of establishing a lump-sum in savings. As the borrower makes payments, the money is typically held in a certificate of deposit or zero-interest savings account that is disbursed upon maturity.
The target market for credit builder loans is twofold: consumers with no credit history, and consumers with subprime credit. Subprime credit is often the result of charge-offs, collections, and bankruptcies, which have been paid off (or nearly).
They usually, but not always, have FICO 8 scores under 670, 5 or fewer derogatory marks, 9 or fewer accounts, and about $10,000 or less in settled derogatory marks.
These consumers have low creditworthiness, which prevents them from obtaining financing loans like mortgages, car loans, and business loans.
Credit-builders provide a solution to the "vicious cycle of credit" by creating payment history and diversifying credit mix to push consumers into prime credit ranges. Prime credit provides access wealth-creating debt like mortgages that help break the cycle.
Credit-builder loans are unique to countries with systematic consumer credit reporting via agencies such as private companies TransUnion, Experian, and Equifax, which include the United States, Australia, Canada and the United Kingdom.
Consumers across these 3 countries and in any U.S. state who want to build their credit can use credit builder loans through domestic lenders.
While over 23 other countries have some form of consumer reporting, the activity is usually administered by government entities. They usually restrict tracking to major accounts such as mortgages and negative items with fundamental delinquencies like default.
In most cases, only large financial institutions may access this information and cannot share it with anyone. Examples include France and Spain. Credit builder loans won't help there.
Credit builder loans are among the easiest loans to get. They require the same steps as traditional personal loans to obtain yet have the lowest credit requirements of any installment loan.
Borrowers with lender type requirements, geographical limitations, or other constraints may face some challenges in selecting a CBL. The important point is that these challenges are a result of borrower demands and not lender criteria.
Noah Gomez (founder of Thick Credit) is a transatlantic professional and entrepreneur with 3+ years experience in consumer finance education. He also has 5+ years of experience in corporate finance, including debt financing, M&A, listing preparation, US GAAP and IFRS.
Thick Credit is not a credit repair organization, a credit conseling agency, or a debtor education providor. It does not act on your behalf to communicate with credit reporting agencies or provide pre-bankruptcy credit counseling and pre-discharge debtor education for bankruptcy.
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