Credit Builder Loans vs. Personal Loans: Everything You Need to Know

If you need to build credit, one way is through a loan. You might be able to use a credit card or personal loan to accomplish this purpose, but a credit builder loan might make more sense.

Here’s what you need to know about a credit builder loan vs. a personal loan.

Credit Builder Loan vs. Personal Loan: An Overview

A standard personal loan works by providing a borrower with a lump sum of funding at the beginning of the loan term. Over time, the borrower repays the debt with interest, making payments in regular installments.

On the other hand, a credit builder loan provides borrowers with the funds at the end of the term (i.e., after all payments have been made).

While both a credit builder and personal loan can help you potentially improve your credit situation, they have different intended purposes.

Credit Builder Loan

A credit builder loan is usually offered to someone who doesn’t have a credit history or who has such a sparse history that they are essentially “unscorable.” Using a credit builder loan to rebuild a credit score is also possible if you have poor credit.

In many cases, a credit builder loan works as follows:

• Your lender puts the loan amount in a separate account, such as a certificate of deposit (CD).
• You make regular installment payments to the lender, paying off the loan, including interest payments.
• After the loan has been paid off, the money in the separate account is given to you.

It’s important to note that a credit builder loan is still a loan, so you’re still paying interest. You just make all of your payments before receiving the funding. Credit builder loans can have terms typically ranging from six to 24 months.

Before getting a credit builder loan, consider how long you can wait for the money. Also, since you’re still paying interest, you’ll ultimately pay more overall than the amount you receive, even though you don’t get the money until after the terms are fulfilled. The longer your term, the more you’ll pay in interest. Depending on your situation, getting a shorter loan term might make the most sense if you just need to build credit.

How to Qualify for a Credit Builder Loan

Some credit builder loans don’t require a credit check, but you might still be subject to one—just as with any other type of personal loan. Even if you have no credit history or poor credit, you might still be able to get a credit builder loan. However, you might need to show sufficient proof of income to receive the loan.

In general, you can expect to provide proof of your identity (typically using a state-issued ID), and you might need to provide bank statements or pay stubs to establish your income. It’s also worth noting that you might be able to get a lower interest rate with a credit builder loan than you would with a personal loan, especially if you have a low credit score.

Personal Loan

On the other hand, a personal loan typically denotes a more traditional loan. You apply for the loan and receive your funding upfront, usually as a lump sum. Over time, you make regular payments of the principal plus interest until you’ve paid off the amount you borrowed.

Most personal loans are unsecured, meaning you don’t need to provide collateral, such as a car or real estate, that the lender can repossess if you fail to fulfill your obligation. A personal loan might have higher interest rates than other types of loans due to their unsecured nature. Borrowers with poor credit who receive personal loans might find the interest rates quite high.

Many personal loans are fairly flexible, allowing you to choose terms of 12 months to seven years (or more).

How to Qualify for a Personal Loan

Credit requirements might be more stringent for a personal loan than for a credit builder loan. You generally need to be pre-qualified with a soft credit check, and then the lender will make an offer. Once you accept the offer, you fill out an application, and a hard credit inquiry is made. That hard inquiry might impact your credit score.

Note that pre-qualification doesn’t mean that you’ll receive the amount you initially applied for or the interest rate you were quoted. The final terms of the loan will be revealed before you accept. Read them carefully so you understand what to expect.

Generally, you need to provide proof of income and documentation verifying your identity. You might need to provide bank statements to qualify. The amount of money you receive will be based on your income, current debt balances, credit score, and other criteria set by the lender.

How Do People Use Personal Loans?

Investopedia commissioned a national survey of 962 U.S. adults between Aug. 14, 2023, to Sept. 15, 2023, who had taken out a personal loan to learn how they used their loan proceeds and how they might use future personal loans. Debt consolidation was the most common reason people borrowed money, followed by home improvement and other large expenditures.

Key Differences: Credit Builder Loan vs. Personal Loan

The biggest difference between a credit builder loan and a personal loan is when you get the money. With a credit builder loan, you don’t receive the money until after you’ve made all of your payments. A personal loan provides you with the money upfront, allowing you to use it immediately.

A credit builder loan is specifically designed to help you establish or rebuild your credit history. Once you receive the money, you can use it for whatever you want. However, it’s not a good choice if you need cash fast.

Personal loans are intended to help you make major purchases immediately or deal with a financial emergency. Without waiting until the loan term has passed, you can secure funding much quicker.

The Bottom Line

A credit builder loan could be desirable if your primary goal is to establish or rebuild your credit. It might be worth the cost of interest and fees if you can use a credit builder loan to improve your credit situation, allowing you to take advantage of better rates and other benefits down the line.

On the other hand, a personal loan might make more sense if you can qualify and you need money upfront for a major purchase, debt consolidation, or an emergency.

Carefully consider your situation and financial goals before deciding which type of loan to pursue.