If you need to start rebuilding your credit but are not sure where to begin, a credit-builder loan might be the answer. Credit-builder loans help you establish a savings account while building your credit at the same time. With credit-builder loans, you do not receive an immediate payout. Instead, you make monthly payments that are sent to a personal savings account. Once you pay the loan in full, you receive the loan proceeds.

Why Use a Credit-Builder Loan

There are several advantages to credit-builder loans, especially if you are trying to establish a strong credit history and do not need the money right away. As you continue to make monthly payments, those payments earn interest when the bank places the funds into your savings account. If you make your monthly payments on time, your lender will report those on-time payments to one of the three credit reporting agencies: TransUnion, Experian and Equifax. NerdWallet.com reports that you can raise your credit score by 35 basis points or more if you make on-time payments.

Applying for a Credit-Builder Loan

Small community banks and credit unions are the best places to shop for credit-builder loans. Most of your larger financial institutions and banks do not offer credit-builder loans. According to CreditCards.com, about one in five credit unions offer some type of credit-builder loans. Most borrowers who apply for the loans typically have bad credit or no credit history at all. If you have bad credit, do not let that deter you from applying for a loan. Although you can expect to pay a higher interest rate, you still have a good chance of qualifying and rebuilding your credit.

Secured and Unsecured Credit-builder Loans

Most lenders who offer credit-builder loans give you the option of a standard secured loan or an unsecured loan. A secured loan, also known as a pure credit-builder loan, uses money that you currently have in a checking or savings account as collateral for your loan. However, the lending institution will freeze that account and incrementally release funds to pay down your loan.

Unsecured credit-builder loans allow you to receive the loan proceeds up front. If you have a shaky credit score, you will pay a much higher interest rate. The good news is that many of the lenders offering this type of loan will refund the interest you paid over the life of the loan if you pay off the loan as agreed. The loan amounts are much smaller on unsecured loans with most lending institutions offering a maximum of $500.