Pros and cons of credit-building products

Credit-building products may be able to help those who are just starting out on their personal finance journey or who have hit some bumps. These products can help borrowers to build a more solid and positive credit history. However, loans may be limited in size and high interest. Research your options upfront to make the best decision.

What are credit-building products?

A credit-building product is a loan, service or app that helps consumers learn about, improve or develop their credit scores.

Credit-building loan products are designed to give borrowers who don’t qualify for traditional loans a chance to prove their creditworthiness with flexible eligibility requirements. They are typically more restrictive than other types of credit, with comparatively low borrowing limits and, in some cases, required collateral. That said, these products can be a great starting point for some borrowers.

Credit-building apps provide you with educational articles, credit monitoring services and other content. They’re meant to teach you the basics of credit score building so you can make good credit decisions.

Types of credit-building products

A variety of credit-building products are available on the market. Some products may be a better fit than others, and you will want to consider the terms, fees, and interest rates involved when choosing which one to use.

Common types of credit-building products include:

• Credit builder loans.
• Small dollar loans.
• Secured credit cards.
• Credit-building apps.

What are the costs of credit-building products?

Each type of credit-building product may come with costs. You’ll typically pay interest charges and origination fees with any credit-building loan. However, the APRs and costs are much lower than other no-credit loans like payday loans and auto title financing.

There are several online credit monitoring services and tools. Some may require a monthly subscription fee that will vary depending on how often and for how long you want to track your credit scores. Most can be canceled anytime and may offer a free introductory period.

The cost of these credit-building products may be worth it if they help you build a good credit score and positive credit habits.

Pros and cons of each credit-building product

You can build credit in a variety of different ways. Knowing the pros and cons of each credit-building product can help you focus on those that can set a solid foundation for getting the best terms on future credit.

Small dollar loans

Six national banks offer small-dollar loans as a lower-cost alternative to payday loans. Small-dollar loans are easier to qualify for than personal loans and are heavily regulated by the Consumer Protection Act. APRs that can’t exceed 36 percent and must be paid in equal installments. You can’t borrow more than $2,500, although many small-dollar lenders set a lower maximum of $1,000.

You can get a small-dollar loan by checking with your local bank or credit union — or one of the national banks that offer them.

Pros

• More flexible qualifying requirements than traditional loan products.
• Much lower APRs than payday loans.
• Payments are reported to at least one credit bureau.

Cons

• Can’t borrow more than $2,500.
• Not available in every state.
• May be harder to qualify for than payday loans.

Credit-builder loans

Credit-builder loans are typically for loan amounts between $300 and $1,000 and cater to borrowers with little to no credit history. Unlike a regular loan, you don’t receive your credit upfront. Instead, you make payments for a set period and receive the funds either as you pay them back or once you’ve completed the payment schedule — which typically ranges between 12 and 36 months.

Pros

• Each payment is reported to credit bureaus which can help improve your score over time.
• Borrowers without an established credit history can qualify.
• You can choose a small loan amount to keep the payment affordable.

Cons

• You don’t receive any funds upfront.
• Not a good option if you need the cash for living expenses or emergencies.
• There may be ongoing fees.

Secured credit cards

Secured credit cards are just what their name suggests: credit cards secured by cash you give the lender. They are typically easy to qualify for since you put up the money for the amount you want to borrow. If payments are made on time, you can improve your credit score. Some lenders will offer you an unsecured credit card once you’ve proven you can manage funds in a secured credit card.

Pippin Wilbers, personal loans editor at Bankrate, opted for a secured credit card through his credit union when he wanted to start building credit in his early 20s.

“I had decent savings but absolutely no credit history, and I wanted to make sure I could qualify to rent an apartment,” he explains.

He started using the card for small, daily purchases like groceries and paying down the balance immediately, keeping his credit utilization low and never having to pay interest. Even with no other credit products in his portfolio, this approach helped him build a score in the 700s.

Pros

• May not require a credit score to qualify.
• Credit score may increase with regular, on-time payments.
• Helps the credit utilization ratio portion of your credit score if you keep the balance low.

Cons

• Require an upfront cash security deposit equal to the amount of credit you apply for.
• Could hurt your score if you max the credit card balance out.
• Higher APRs and costs than most unsecured credit cards.

Credit-builder apps

Credit-builder apps help you track and grow your credit score through educational resources, financial tracking tools and lending options.

Most apps organize and streamline the application and repayment process for other credit-building products. Others exist to help you monitor and manage your score on a daily, weekly or monthly basis.

Pros

• Allows you to track your payments and balances on credit-builder loan products easily with your smartphone.
• Most offer tools and educational resources to help you maintain good credit health.
• Some apps will help you track the movement in your credit scores.

Cons

• Require a working smartphone.
• Apps may have confusing features or may not work as advertised.

What is the best way to build my credit?

The best way to build credit is to pay your bills on time and use borrowing as a last resort.

Keep your credit card balances low or pay them off every month. Avoid applying for several credit accounts at once and check your credit report at least once a year for mistakes. Put extra room in your budget for emergency savings so you don’t have to borrow money when unexpected expenses crop up.

Always shop around with several lenders to ensure you’re getting the best rates at the lowest costs. For installment loans, including personal and auto loans, choose carefully between longer terms to keep your payments low or shorter terms to pay off your balance quickly.

Regardless of the method you choose, improving your credit profile can make accessing credit easier in the future. Even just graduating from a bad or thin credit profile can help you get fair credit loan rates, which can save hundreds compared to their bad credit counterparts.

Other ways to build credit

There are some other simple ways to help you build credit.

• Consider a co-signer. You may be able to add a family member or friend to your application as a co-signer to help you improve your chances of landing a loan to improve your credit. They’ll be on the hook if you can’t repay the loan, so discuss the decision in advance and keep them informed if you have trouble making payments.
• Check out alternative credit reporting offers. Some credit companies offer services that add payments on day-to-day expenses to your credit history. For example, Experian Boost will add the payment history on utility bills and subscription services to your credit history, which may help your credit score.
• Become an authorized user. Parents sometimes add their teenage or college-aged kids to their credit cards to help them establish a credit score. Just make sure you understand any rules for using the cards to avoid surprises that may tank your — or your parents’ — credit scores.

The bottom line

Credit-building products offer different methods for building and improving your credit score. Used wisely, they may help you qualify for bigger loans — like a mortgage or auto loan — in the future. Be sure to research the options and read the fine print. Look for the interest rates and terms that will be most favorable for you.

Frequently asked questions about credit-builder tools and products

• Are credit-building tools safe?

  Credit-building tools are just as safe as any other loan or card if you get them through a bank, credit union or reputable online lender. Never pay any money upfront for approval, and ensure you understand the terms of any type of credit-builder loan before you sign the final paperwork.

• How fast will a credit-building product improve my credit?

  It may take several months to see a score or improvement after borrowing a credit-builder loan. Wait to open any other lines of credit while making payments — additional credit inquiries could lower your scores. If your score is low, you’ll need multiple months or even years of good habits to boost your credit.

• What’s the best credit-building tool?

  Credit-builder loans, secured credit cards and small-dollar loans are best if you have room in your budget to take on a new monthly payment. Credit builder loans and small-dollar loans usually have fixed payments, so you have no flexibility if you have an unexpected drop in income.

  Secured credit cards usually have a minimum payment option if you have unpredictable earnings, but you could hurt your score if you carry a high balance. Credit-building apps are a great way to see your progress over time and learn how to manage your credit responsibly.