How to choose the best credit-builder loan for you

While taking out a loan to improve your credit score may feel counterintuitive, it can be a practical approach as long as you handle the loan responsibly. A credit-builder loan is designed to assist borrowers who need to build or improve credit from square one.

After applying and being approved, your loan balance will often be added to a savings account. By successfully making fixed payments, you will build your credit and savings at the same time. When considering which option best suits your needs, it is essential to look out for certain factors, similar to when shopping for a traditional personal loan. Also, assess where it makes sense to find the best credit-building loans for your situation.

6 factors to consider when choosing the best credit-builder loan

When comparing options, consider the following factors to find the best credit builder loans.

APR

Although these sorts of loans aim to build your credit, there is a cost to that formation. The annual percentage rate (APR) tends to fall between 5 percent and 36 percent, with credit unions often offering lower APRs. The higher the interest rate is, the more you will have to pay each month.

Fees

The cost to apply and keep up with your loan varies by lender. These small fees can account for the loan application, administration or a late payment fee.

It is best to sign up for automatic payments to avoid costs accrued for missing payments. If you are working with a tight budget, shopping with lenders that advertise minimal or zero fees is wise.

Loan terms

The loan terms are the period you have to pay off your credit-builder loan. In the case of these sorts of loans, borrowers can expect repayment terms of six to 24 months — but some offer terms up to 48 months.

The longer you extend your loan term, the lower your monthly payment tends to be. Credit-builder loans are shorter-term as the product is intended to be small amounts paid off quickly.

Additional features

When comparing options with similar rates, explore how special features offered could sweeten the deal. If you want consistent updates, look for a lender that will share FICO score changes. Also, look out for lenders that report to all three credit bureaus, given the primary purpose is to build your credit score. Other features lenders might offer include deferred payments to help those on a tight budget.

Customer service

Credit-builder loans can be found at various sources, including brick-and-mortar banks or online lenders. When determining which source best fits your needs, consider your business preference. If you feel confident navigating your finances online, an online lender is a good option. If you prefer additional, customized assistance, consider checking out a bank or credit union with offices in your area.

Reputation

Smaller banks and credit unions may offer credit-builder loans. Just because they are less prominent institutions doesn’t mean they are not trustworthy. However, not all lenders on the market are trustworthy.

Check online reviews and the Better Business Bureau to ensure you aren’t sharing financial information with a risky source. Doing the extra research and seeking actual customer testimonials from a third-party rating site can help you borrow more confidently.

Where to find credit-builder loans

You can find credit-builder loans from several different places:

Banks: Community banks can be a good place to secure a loan if you like the in-person customer service and local offices these establishments typically provide. However, they tend to cost more.

Credit unions: Credit unions often have local offices and in-person customer service. However, credit unions may come with added perks, like fewer account fees or lower interest rates on loans. Credit unions operate as nonprofits and typically have lower overhead costs than banks, often translating into more affordable services for the consumer.

Online lenders: Online loan lenders may offer some of the best credit builder loans. The lack of brick-and-mortar overhead may translate into more competitive rates. Choose this option if you’re mainly concerned with the convenience of doing everything online and faster processing, from applications to payments. However, with online lenders, you have to do more background research through sources like the BBB to make sure they are legitimate lenders since you can’t see them in person.

Lending circles: This is an alternative option. These groups contribute a fixed amount of money into a shared pool. Then, each member of the group gets funds on a rotating schedule. This method can avoid interest and fees. Look for lending circles that are managed by reputable nonprofits and institutions that can report to the credit bureaus to help you build credit.

Next steps

The purpose of a credit-builder loan is to do just that: build your credit. To achieve the financial strength that a good credit score brings, you must secure a loan you can afford and pay off on time. When shopping, pay close attention to your monthly payment and specific needs.