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

While taking out a loan to improve your credit score may feel counterintuitive, it can be practical if 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.

APR

Although credit-builder loans aim to build your credit, there is a cost to using them. The annual percentage rate (APR) — interest rate and fees, expressed as a percentage — tends to fall between 5 percent and 36 percent. Credit unions often offer lower rates for credit-builder loans, sometimes as low as 0 percent. The higher the APR on a loan is, the more you will have to pay each month and overall.

Fees

The cost to apply and keep up with your loan varies by lender. These small fees may include loan application, administration or late payment fees. If you are working with a tight budget, it’s smart to shop with lenders that advertise minimal or zero fees.

Some of the personal loan fees to look out for when researching lenders include:

• Application fees.
• Origination fees.
• Late fees.
• Overdraft or returned payment fees.
• Early repayment or prepayment fee.

If you have a steady source of income, many lenders offer automatic payments.

Loan terms

The loan term is the period you have to pay off your credit-builder loan. In general, repayment terms last six to 24 months — but some lenders offer terms of up to 60 months.

The longer you extend your loan term, the lower your monthly payment tends to be. Credit-builder loans typically have a shorter term since they are intended to be small amounts paid off quickly.

Other credit-building products, however, may not have the same type of repayment terms. When using a secured credit card, you’ll be expected to make monthly payments on any debt accrued. A credit-building app is typically an educational platform that monitors your credit profile and identifies areas for potential improvement, but if you borrow through it, your terms will depend largely on your lender.

Customer service

Credit-builder loans are available from banks, credit unions and online lenders. However, your options may be limited. Not every lender will offer this product, so look into local options before you expand your search to larger, national 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. For 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 lender 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.

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 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 or the ability to move your due date.

Where to find credit-builder loans

You can find credit-builder loans from several types of lenders. When comparing your options, apply for prequalification with multiple lenders, including:

• 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. Choosing a bank you already do business with may afford you a better chance of qualifying and potentially better rates.
• Credit unions: Credit unions often have local offices and in-person customer service. However, 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 can translate into more competitive rates. You will have to do more background research through sources like the Better Business Bureau to make sure any online lender you choose is legitimate 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, usually at little to no cost. Look for lending circles that are managed by reputable nonprofits and institutions that can report to the credit bureaus to help you build credit.

Bottom line

The purpose of a credit-builder loan is to do just that: build your credit. When shopping, pay close attention to your monthly payment and specific needs. Doing so will help you get a credit-builder loan that fits your budget and helps you improve your score.

Once you build your credit, you can look into options like good credit loans to continue working towards a positive payment history and better score.