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If you’re trying to build your credit, you may encounter a bit of a Catch-22: You likely need a good credit history to successfully apply for credit. But how do you do that if you don’t have credit?

Fortunately, products like credit builder loans and secured credit cards can help you build a favorable credit profile if you’re still at the beginning of your journey. Deciding which of these financial products is best will depend on your immediate financial needs and how much cash you have available to put down for a security deposit.

Read on to learn more, including:

•   What is a credit builder loan?

•   How does a credit builder loan work?

•   What are the pros and cons of credit builder loans?

•   What is a secured credit card?

•   How does a secured credit card work?

•   What are the pros and cons of secured credit cards?

•   Which is better of a secured credit card vs. a credit builder loan?

What Is a Secured Credit Card?

Secured credit cards vs. unsecured credit cards may look the same, but they work a little differently.

Instead of setting a credit limit determined by your credit history, secured cards require a cash security deposit. The amount of your deposit is usually the same as your limit.

You can think of it this way: Rather than allowing you to borrow money, the credit issuer is essentially allowing you to spend money you already have. It may sound as if it doesn’t offer any benefit, but remember: This gives you the opportunity to build your credit.

How Secured Credit Cards Work

When you apply for a secured credit card, you’ll provide your basic demographic information along with a cash security deposit to the card issuer. This deposit will usually be at least $200 or $300 and could be more; say, $1,000 or $2,500.

The deposit amount will likely serve as your working credit limit, though you may want to use the card sparingly. Perhaps you swipe or tap it often enough to keep it open and for the credit bureaus to see your positive credit behavior, such as paying in full and on time each month.

Because the cash deposit works as collateral, lowering the risk for the card issuer, you may be able to successfully apply for a secured credit card with a lower credit score or possibly even no credit at all. The same issuer might even automatically review the account to see if it merits a switch to an unsecured card.

Recommended: How to Apply for a Credit Card

Secured Credit Card’s Effect on Credit

Secured credit cards offer you the opportunity to build positive credit history, since your balance, payments, and other information will be passed to the credit bureaus. And because the credit limits are generally lower, it’s a lot harder to fall into a serious debt spiral with a secured credit card than it is with an unsecured one.

Pros and Cons of Secured Credit Cards

Like any financial option, secured credit cards have both pros and cons to consider.

Pros of secured credit cards:

•   It’s a readily available way for those with poor or non-existent credit history to begin building their credit with a low cash deposit.

•   You gain the ability to use the funds immediately while still building credit over time.

•   You may gain some potential credit card benefits, such as fraud protection and credit card rewards, like cash back.

Cons of secured credit cards:

•   You must have the cash deposit available, and it can be in your best interest not to use the entire amount once you have the credit card. That means some of your money is tied up on the card.

•   Interest and penalties may apply if you aren’t able to keep your balance low or paid off in full each month.

•   Card issuers do still run a hard credit inquiry when you apply, which can negatively impact your credit in the short term.

Recommended: What Is the Average Credit Limit and How Can You Increase It?

What Are Credit Builder Loans?

Credit builder loans are another option for people looking to build their credit. They work a little differently than a traditional loan does. Rather than receiving the money you’ve applied for right away, you’ll get the money later, after you’ve repaid the full amount.

How Do Credit Builder Loans Work?

Applying for a credit builder loan is a lot like applying for any other unsecured or secured personal loan. You’ll provide a variety of information, including details about your existing monthly expenses and income, as part of the approval process. (The lender may or may not run a credit check or look into your banking history.)

These loans are typically for relatively small amounts of $300 to $1,000. The term is likely to be between six and 24 months; rates will vary.

If you’re approved, the bank will create a savings account or certificate of deposit (CD) in the amount of the loan. The money is held there rather than paid out to you, and you repay the debt over time. It’s only when you’ve successfully completed repayment that the money be disbursed to you (sometimes including accrued interest).

In this way, it’s kind of like an enforced savings plan: You could slowly put money away into a savings account yourself, but taking out a credit builder loan keeps you accountable.

Plus, your payments are reported to the credit bureaus, which means you have the opportunity to build your credit history and credit report in the meantime. Win-win!

Note: Credit builder loans may not be available at your financial institution. If that’s the case, check credit unions, CDFIs (Community Development Financial Institutions), and online lenders.

Credit Builder Loan’s Effect on Credit

The loan company will report your on-time payments to the credit bureaus, which can help you build your credit. This can make it a lot easier to take out other loans in the future.

Of course, if you fail to pay on time or default, a credit builder loan could have a negative effect on your credit.

Pros and Cons of Credit Builder Loans

Credit builder loans also have both positives and negatives to consider.

Pros of credit builder loans:

•   They are available to people with low or no credit.

•   They may not require a hard credit inquiry.

•   They can help people build credit without risking going into credit card debt.

Cons of Credit Builder loans:

•   You won’t have access to the funds until after you’ve paid the loan off. Credit builder loans might not be right for those who have immediate financial needs.

•   There may be a nonrefundable fee for taking out the loan.

•   These loans can be difficult to find.

Credit Builder Loans vs Secured Credit Cards

Which of these two credit-building options might be right for you? The answer depends on your circumstances, but this table might prove helpful in comparing the options.

Is a Secured Credit Card or Credit Builder Loan Right for You?

Depending on your specific financial circumstances, either of these products might be a valuable way to enhance or establish your credit. Both are relatively easy to access for those with imperfect financial histories. Although both require an up-front cash deposit, the deposit may only be a few hundred dollars.

If you need to use your money right away, a secured credit card may make more sense; you’ll be able to use your credit card to pay bills and cover other expenses.

A credit builder loan, on the other hand, ties up your money for a longer period of time, but comes with less risk of paying large amounts of interest on revolving debt.

The Takeaway

Credit builder loans and secured credit cards make it possible to create a favorable credit history. A credit builder loan may be a better option for those who have more cash available, whereas a secured credit card helps build credit while (responsibly) spending.

Whether you're looking to build credit, apply for a new credit card, or save money with the cards you have, it's important to understand the options that are best for you. Learn more about credit cards by exploring this credit card guide.

FAQ

What is the difference between a credit builder loan and a secured credit card?

A credit builder loan is a loan that disburses money to the borrower only once the entire amount has been paid to the bank. A secured credit card is a credit card that requires a cash deposit to open. Both of these strategies require an up-front cash investment, but they also give people with poor or nonexistent credit the opportunity to build positive credit history and improve their credit score.

Which is better for building credit: a loan or a credit card?

Both loans and credit cards can build credit over time if the borrower makes their payments on-time and in full. However, both can also pose risk if the borrower is unable to keep up with repayment. Deciding whether to get a credit builder loan or a secured credit card may depend on how soon you need access to your cash.

What is one disadvantage of a credit builder loan?

When you take out a credit builder loan, you won’t have access to the money you’re applying for until the loan’s term is up, which may be as long as 24 months. That means credit builder loans might not be right for people with short-term financial needs to take care of.

Photo credit: iStock/staticnak1983

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

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CeFi and DeFi are two terms that have become increasingly popular in the world of finance and cryptocurrency. CeFi, or Centralized Finance, refers to crypto and blockchain companies that operate like traditional financial systems, meaning a private central authority controls them and users are customers. DeFi, or Decentralized Finance, on the other hand, is a new type of financial system that operates on a blockchain network. Unlike CeFi, DeFi products and services are not controlled by a private central authority but are managed by an open-source network of computers.

While CeFi and DeFi may sound similar and have similar functions, there are some critical differences between the two. Investors should know this before investing in cryptocurrencies or blockchain technology.

DeFi vs CeFi: Similarities

Decentralized finance (DeFi) and centralized finance (CeFi) are more known for the distinction between the two financial systems. Nonetheless, DeFi and CeFi have several things in common:

Financial Services

As their names suggest, DeFi and CeFi platforms allow users to access financial services such as lending, payments, and trading securities exchanges. They also both use digital assets as collateral for these services.

Also, a large number of people around the world can access DeFi and CeFi products, making it easy for individuals and businesses to access financial services regardless of their location.

Recommended: Centralized vs. Decentralized Exchanges: Six Differences to Consider

Use of Technology

Another similarity is that both DeFi and CeFi platforms use digital and internet-based technologies to provide financial services. DeFi platforms are built on blockchain technology, while CeFi platforms use traditional technologies such as databases and servers to provide their services, in addition to some use of blockchain technology. These technologies allow both algorithms and automated processes to facilitate financial transactions and provide financial services, making it easier and more efficient to conduct financial transactions.

DeFi vs CeFi: Differences

As noted above, DeFi and CeFi are more known for their differences than similarities. Some of these differences include the following:

Centralization

DeFi is decentralized, meaning that a single entity, such as a bank or government, does not control it. Instead, it often relies on decentralized autonomous organizations (DAOs), open source networks, and decentralized ledgers, such as a blockchain, to facilitate financial transactions and provide financial services. CeFi, on the other hand, is centralized, meaning that a single private entity, such as a bank or financial institution, controls it.

Asset Custody

Asset custody refers to the process of securely holding and managing digital assets, such as cryptocurrencies, on behalf of users. Asset custody is a critical component of DeFi, as it ensures the security and integrity of users’ assets and helps prevent theft and fraud. In DeFi, users generally manage their digital assets directly, using a crypto wallet or other secure storage solution. In contrast, CeFi platforms generally act as a user’s asset custodian, meaning they control the assets.

Smart Contracts

DeFi relies on smart contracts, self-executing contracts with the terms of the agreement between buyer and seller directly written into lines of code. Smart contracts enable DeFi transactions to be transparent, secure, and automated. CeFi does not use smart contracts and instead relies on traditional contracts and intermediaries to facilitate financial transactions.

Transparency

Some experts consider DeFi more transparent than CeFi, as it relies on public decentralized networks and blockchain technology; users and researchers can track transactions in case of issues. CeFi, on the other hand, is vulnerable to centralized points of failure, such as hacks and data breaches.

Innovation

DeFi is often considered more innovative and experimental than CeFi, as it is a newer and less established financial system constantly evolving and exploring new technologies and approaches. CeFi, on the other hand, is a more established and traditional financial system that tends to be more conservative and risk-averse.

Customer Service

CeFi companies usually have robust customer support staff to assist users when they encounter issues. This customer service gives users a sense of security. In contrast, there are fewer customer support services with DeFi platforms, which may be an issue if problems arise when using the products.

Regulations

CeFi companies are subject to laws and regulations by government agencies and financial authorities, which aim to ensure the integrity and stability of the financial system. Some regulations include Know Your Customer (KYC) and anti-money laundering rules. In contrast, DeFi platforms operate in a regulatory gray zone.

Pros and Cons of DeFi

DeFi has both pros and cons. Some of the main advantages of DeFi include greater accessibility and control for users. Because DeFi platforms are built on blockchain technology and operate without the need for a central authority, they offer users greater control over their assets. Additionally, the open source and decentralized nature of the blockchain may make DeFi platforms, like decentralized exchanges (DEX), resistant to sudden changes because users can observe and verify operations.

However, DeFi also has some disadvantages. One of the main disadvantages is the lack of regulatory oversight. Because DeFi platforms operate without the need for a central authority, they are not subject to the same level of regulatory oversight as traditional financial institutions. This can make it difficult for users to know if they are using a trustworthy DeFi platform and they can be susceptible to fraud and scams.

Another disadvantage is the potential for technical issues. Because DeFi platforms are built on complex technology such as smart contracts and blockchain, there is a risk of technical issues arising that could affect the platform’s functionality. Relatedly, DeFi usually has difficult user experience which prevents non-tech savvy users access to the platforms.

Pros and Cons of CeFi

Some of the main advantages of CeFi include stability and security. Because CeFi platforms are controlled by a central authority, they are subject to regulatory oversight and may be more stable and secure than decentralized platforms. This can provide users with a greater sense of trust and confidence in the platform.

Another advantage of CeFi is the ability to access a broader range of financial services. Because CeFi platforms are typically operated by institutions with ties to traditional finance, they can offer a wider range of services, such as loans, credit cards, and investment products. Additionally, CeFi companies can offer seamless conversion of digital assets to fiat currency and vice versa. This can provide users with more options and flexibility.

However, CeFi also has some disadvantages. One of the main disadvantages is the lack of control for users. Because CeFi platforms are controlled by a central authority, users are subject to the policies and regulations of that authority. This can limit users’ ability to access and control their own assets.

Another disadvantage is the potential for censorship. Because CeFi platforms are controlled by a central authority, there is a risk that the authority could censor certain transactions or activities on the platform. This could limit users’ freedom and ability to access certain services.

Can CeFi and DeFi Work Together?

Many analysts believe it is possible for CeFi and DeFi to work together. While the two types of platforms have some differences, they also have some similarities and can potentially complement each other.

One way that CeFi and DeFi could work together is by combining the strengths of both types of platforms. For example, DeFi could provide the accessibility and control that users desire, while CeFi could provide the stability and security of traditional financial institutions. This could allow for a more balanced and comprehensive approach to finance.

Another way that CeFi and DeFi could work together is through the use of interoperability. Interoperability refers to the ability of different systems or platforms to work together and exchange data. By using interoperability, CeFi and DeFi platforms could share information and services, allowing users to access a wider range of financial services.

The Takeaway

CeFi and DeFi offer unique opportunities for investors and users to access financial services and products. CeFi is typically more regulated and centralized, while DeFi is more decentralized and operates outside of traditional financial systems. Both have their advantages and disadvantages, and it is up to the individual investor or users to decide which platform best fits their needs and goals. Ultimately, the choice between CeFi and DeFi will depend on an individual’s risk tolerance, preference for regulation, and desire for decentralization.

FAQ

How does DeFi differ from centralized finance?

DeFi differs from centralized finance in several key ways. The main difference is that DeFi platforms operate without a central authority, whereas centralized finance relies on traditional financial institutions controlled by a central authority. This lack of a central authority in DeFi means that users theoretically have complete control over their assets and are not subject to the policies and regulations of a central authority. In contrast, centralized finance is subject to the policies and regulations of the institutions and governments that control and oversee it.

How are crypto and DeFi different?

Cryptocurrency and DeFi are two related but distinct concepts in finance. Cryptocurrency is a digital asset that uses cryptography for security and operates on a decentralized ledger called the blockchain. DeFi, on the other hand, refers to the use of blockchain technology to provide financial services such as lending, borrowing, and trading without the need for a central authority.

Is all crypto based on decentralized finance?

Not all cryptocurrency is based on decentralized finance. While DeFi is a growing movement in cryptocurrency, not all cryptocurrencies are designed specifically for use in DeFi, like lending or asset trading.

Photo credit: iStock/Delmaine Donson

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