Pros and cons of credit-building products

For those who are just starting out on their personal finance journey or those who have hit some bumps in the road, credit-building products may be able to help. These products are designed to provide education, tools and small amounts of credit to act as steppingstones.

What are credit-building products?

A credit-building product is a loan, service or app that helps people 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.

Credit-building tools and services provide you with educational articles, credit monitoring services and other content that teaches you the basics of credit score building so you can make better credit decisions in the future. You can also benefit from downloading a credit-building app to track your progress.

Credit-builder loans and secured credit cards require more discipline than regular credit accounts. You don’t typically get access to the credit-builder loan funds until you’ve made the payments. Secured credit cards require upfront cash in exchange for credit.

The bottom line: By developing good credit habits with credit-building products, you may avoid needing a bad credit loan later due to poor credit decisions like maxing out credit cards or using payday loans to make ends meet.

What are the costs of credit-building products?

There may be various costs associated with each type of credit-building product. 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 how long you want to track your credit scores. They 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 common-sense 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 the ones that can set a solid foundation for getting the best terms on credit in the future.

Small dollar loans

Six national banks offer small-dollar loans as a lower-cost alternative to payday loans to the residents of 35 U.S. states. 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 the name suggests — credit cards secured by the 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.

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.
• It 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 or 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

• Must have 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 credit 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 to pay for something unexpected.

Always shop around with several lenders to ensure you’re getting the best rates at the lowest costs. For installment loans, like personal loans and auto loans, choose 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 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 often add their teenage or college-age kids to their credit cards to help them establish a credit score. Just make sure you know the rules for using the cards to avoid any surprises that tank your — or your parents’ — credit scores.

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 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 improve or see a score at all after you take out a credit-builder loan. Wait to open any other credit while making payments — additional credit inquiries could lower your scores. If your credit scores are low, you’ll need multiple months or even years of good credit 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 suddenly have a 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.