Do Credit Builder Loans Help?
Credit Builder Loans (CBLs) are small loans offered by financial institutions and promoted as a method for a consumer to improve their credit score and build a savings account. They can be offered with or without additional financial counseling to improve an individual’s overall financial situation.
How They Work
Small loans of $300 – $1,000 are put into a locked savings account by a lender, such as a credit union. The borrower then makes monthly payments over the course of 6 – 24 months to the lender. The borrower can either receive access to the loan upon payment or at the end of the loan, depending on the terms.
Payments include a portion of the loan, or principal, plus a small interest fee charged by the lender. Interest and fees vary depending on the lender’s terms and the borrower’s current financial situation.
They can be offered with or without additional financial coaching. The lender reports the monthly payments to the three major credit reporting agencies: Experian, Equifax, and TransUnion.
- They can help a borrower develop a habit of paying off a loan through monthly payments.
- They have the potential to help a borrower with a low credit score improve their score.
- They have the potential to help a consumer build a savings account and implement savings strategies each month.
- Borrowers who make late payments risk harming their credit scores.
- Additional fees for late payments and returned loan payment checks apply.
- They are more expensive than a savings account due to added interest payments.
A study commissioned by the Consumer Financial Protection Bureau (CFPB) involved 1,531 participants with the goal of evaluating the impact of a CBL on a consumer’s score and savings. The study indicated favorable results for participants who did not have any current debt. For those participants with debt, the results were less favorable.
- Participants with no existing debt saw their credit scores increase on average by 8.9 points.
- Participants with existing debt saw their scores decrease on average by 3.1 points.
- The Consumer Financial Protection Bureau concluded that CBLs have the potential to improve credit scores for consumers without existing debt by up to 60 points. This could potentially move those borrowers to a new score brand.
- The study was not able to find conclusive data about how CBLs might improve a borrower’s savings rate.
Individuals should carefully consider whether a credit building loan is the right option for them. Paying off current debt may be the best first step to begin improving a credit score. For individuals with no debt, credit builder loans could be a way to improve credit scores.
For more information on credit builder loans or this recent study please visit “Targeting credit builder loans” at https://www.consumerfinance.gov/data-research/research-reports/targeting-credit-builder-loans/