Types of credit-building products and how to use them

If you need to improve your credit, there are tools and products available to help boost your credit score or establish a stronger track record. From credit builder loans and secured credit cards to educational credit-building apps, there are numerous options available. Each product works differently, however, so review your options carefully to choose the one that best suits your needs.

Credit-building products to help boost your score

Credit-building products give you a chance to prove to lenders you can manage debt. You typically borrow a small amount and make payments that are reported to credit bureaus to develop a credit history. For some borrowers, these products may be easier to get approved for than traditional credit cards or loans.

The most common credit-building products are credit-builder loans, small-dollar loans, secured credit cards and credit-building apps. Selecting the right product can put you on the path to qualifying for lower personal loan rates in the future.

Credit-builder loans

Pros of credit-builder loans

• Secured with your own funds, so low risk
• Builds payment history
• Depending on the lender, there may be no hard credit inquiry
• You get the principal back at the end of the loan term, minus interest and fees

Cons of credit-builder loans

• Requires a deposit up front
• Can negatively impact credit if you default
• You pay interest and fees
• Usually no cash out until you finish paying the loan

Credit-building loans require you to deposit either a portion or the full amount of your credit line, securing the loan before you can access any funds. If approved, the lender deposits the loan amount into a secured savings account. Each payment you make is reported to at least one of the three credit bureaus, which helps build your credit history and, ideally, your credit score.

Once you make a set number of payments, the lender may release some or all of the funds to you after subtracting any interest charges or fees. You’re usually limited to borrowing between $300 and $1,000, although some lenders may set limits as high as $3,000.

In most cases, the repayment term is between 12 and 36 months. Some lenders, however, offer terms of up to 60 months. Paying off the loan ahead of schedule can actually be counterproductive because it defeats the purpose of borrowing to establish a good payment history.

While you may save on interest by prepaying, you won’t benefit from the on-time payments being reported on your credit report over a longer period, which is instrumental in improving your credit score. If you pay off the loan too quickly, you’ll reduce the opportunity to establish a more thorough positive payment history, which accounts for 35 percent of your credit score.

Who it’s best for:

Credit-building loans are best if you have little to no credit history and don’t need the loan funds immediately.

Small personal loans

Pros of small personal loans

• Funding is available immediately upon approval
• Builds payment history
• Fixed payments
• If used to pay down other high-interest debt, could improve credit utilization

Cons of small personal loans

• Requires a hard credit inquiry
• Interest is sometimes high and fees are common
• Can harm credit if not paid on time

A small personal loan can help build your credit without making you wait for funding. Small-dollar loans must not exceed $2,500 and must also be reported to at least one credit bureau. Like other types of personal loans, they are repaid in installments, with no prepayment penalty if you choose to pay back your loan early.

You can get a small dollar loan at select national and community banks and local credit unions. Online lenders are also one source to comparison-shop for low rates and speedy funding.

The fees are typically charged as a flat rate based on the amount you borrow. Interest rates can be higher, especially if you need to turn to bad credit loans, but they can still help you build a positive payment history.

Who it’s best for:

Small-dollar loans are best suited for borrowers with little to no credit who need a smaller loan amount funded quickly, but want to avoid high-cost payday loans.

Secured credit cards

Pros of secured credit cards

• Builds payment history
• Easier to get approved than unsecured cards
• May be able to move up to an unsecured card once credit is established
• You control your credit utilization

Cons of secured credit cards

• High interest rates and fees
• No access to your deposit until you close the account
• Usually a hard credit inquiry

A secured credit card is a credit card for which your own money serves as collateral. You give the lender cash in the amount you want to secure, and the lender then grants you that much credit.

Like credit-builder loans, you will need to provide funds up front to establish and secure the account. For this reason, if you are short on cash or need quick access to a larger credit line, this product may not be the best fit.

Interest rates and fees are often very high, but your payments and balance are reported to the credit bureaus, which helps you establish a payment history. The high rates and fees may be worth it, however, because secured credit cards are often easier to qualify for than regular credit cards because you effectively give the lender the cash that they then lend to you.

Who it’s best for:

Borrowers who have extra cash to set up a credit account and want to establish a history of paying on a revolving credit line.

Credit-building apps

Pros of credit-building apps

• Specialized focus on building credit
• Most do a soft credit inquiry or none at all

Cons of credit-building apps

• Most are paid, not free apps
• Potential for data privacy issues
• Credit bureau reporting varies by app

Credit-building apps exist to help you build your credit. Some provide credit tracking services to help you become more aware of your score and behaviors, while others provide educational resources to help you build and maintain a strong credit profile.

Apps generally focus on specific areas of building and strengthening your credit, though many combine multiple capabilities.

• Credit reporting and monitoring services will provide information about your current credit score and offer insights on how to strengthen your credit profile.
• Credit-building lenders offer credit-builder and small-dollar loans directly through the app, often via an online lender.
• Bill-pay apps will help you make timely bill payments and report those payments to the credit bureaus to help build your credit.

While an app may sound like the easiest way of checking and strengthening your credit score, be aware that app developers are in the market to make a profit, too. Many apps charge a regular fee to use, and even with a free membership, you’ll be relinquishing your data to a third party for monitoring.

Who it’s best for:

Borrowers who are comfortable using mobile apps and those who are looking for a comprehensive approach to improving their credit.

Best credit-building practices

• Pay your bills on time. Regardless of the type of credit-builder loan you borrow, your credit score will drop if you don’t make payments on time. Keep on top of them by scheduling reminders or using autopay.
• Keep your credit card balances low. Besides paying late, the fastest way to weaken your credit scores is to max out revolving debt, like credit cards. Generally, avoid using more than 30 percent of your available credit. For example, if you can access $1,000 worth of total credit, don’t use more than $300 in a single billing cycle.
• Research alternative credit reporting options. You can add on-time household bills or subscription services you use regularly to your credit report to improve your score. For example, Experian Boost allows you to add up to two years of payment history for utility bills or streaming services to your credit report, which could help increase your scores.
• Find a cosigner. Some creditors allow you to add someone else’s credit and income as a cosigner to help you qualify for a new account. They’ll be on the hook for the debt as well, so make sure everyone understands the responsibilities before you choose this option.
• Ask to be an authorized user. Ask a parent or relative if you could be added as an authorized user on one of their existing accounts. This is a common way for teenagers or new adults to generate a credit score. Ensure you discuss boundaries and expectations for using the card to avoid misunderstandings, especially because mishandling the account will affect both of you.

Bottom line

If you want to establish or repair your credit, several options for credit-building products are available to help. The first step is to decide whether you have the funds to establish a secured line of credit. If not, you will need to explore borrowing an unsecured credit line or a personal loan.

Carefully compare rates, terms, and repayment options before committing to a product. And, in the meantime, be sure you’re making all payments on time and keeping your credit card balances low.