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 along the way. These products can help you build a positive credit history, but the loans you qualify for may be limited in size and have high interest rates. 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 high interest rates. In some cases, they may also require collateral. That said, these products can be a great starting point for some borrowers.

Credit-building apps may offer educational articles, credit monitoring services and other financial resources. They are meant to teach you the basics of credit so you can make informed decisions in the future.

What are the costs of credit-building products?

Each type of credit-building product may come with its own interest rates, fees and other costs. You’ll typically pay interest and origination fees with any credit-building loan, and while rates may be high, they are typically much lower than other no-credit loans like payday loans and title loans.

There are several online credit-monitoring services and tools available as well. 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 any time 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.

Common credit-building products

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 personal loans

Only a handful of national banks offer small personal loans as a lower-cost alternative to payday loans, but you may be able to find them with credit unions and online lenders as well. In general, you won’t be able to borrow more than $2,500, although many small-dollar lenders set a lower maximum of $1,000.

Small personal loans may be easier to qualify for than traditional personal loans, and the Consumer Protection Act heavily regulates how much lenders can charge. The annual percentage rate (APR) you are charged can’t exceed 36 percent, and loans must be paid in equal installments.

You can get a small-dollar loan by applying with a lender you qualify for. Start by checking your local bank or credit union, then move on to online lenders or one of the national banks that offers them.

Pros

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

Cons

• Maximum loan amount capped at $2,500.
• Not available in every state.
• May be harder to qualify for than payday loans.

Credit-builder loans

Credit-builder loans are typically between $300 and $1,000. They cater to borrowers with little to no credit history, and 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.
• Borrowers without an established credit history can qualify.
• Small loan amounts keep payments affordable.

Cons

• Funds are received after payment, not upfront.
• Not a good option for emergencies.
• Ongoing fees and interest can add additional costs.

Secured credit cards

Secured credit cards are secured by cash you give the lender. They are typically easy to qualify for since you pay upfront and borrow from your credit limit. 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 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. By paying down the balance immediately and keeping his credit utilization low, this approach helped him build a score in the 700s — even with no other credit products in his portfolio.

Pros

• Credit score may not be required to qualify.
• Regular, on-time payments can build your credit.
• May help you maintain a low credit utilization ratio.

Cons

• Requires an upfront cash security deposit.
• Could lower your score if you max out your balance.
• Higher rates than most unsecured credit cards.

Credit-builder apps

You can track and grow your credit score with credit-builder apps. These generally offer educational resources, financial tracking tools and lending options.

Some apps 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. Because of the variety of options, you should explore each app’s features carefully to determine which will benefit your credit-building journey best.

Pros

• Track payments and balances on credit-building products.
• Tools and educational resources are available to help you maintain good credit health.
• Some apps will help you track the movement in your credit scores.

Cons

• Requires a working smartphone.
• Apps may have confusing features or may not work as advertised.
• Not all apps have the same features.

What is the best way to build 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 come up.

If you do need to borrow, compare several lenders to ensure you’re getting the best personal loan rates. 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 competitive rates for fair credit loan, which can save hundreds of dollars in interest and fees compared to a loan for bad credit.

Which credit-building tool should I use?

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 limited to 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 they 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.

Other ways to build credit

There are some other simple ways to help you build credit. A cosigner, alternative credit reporting and asking to be an authorized user can all boost your score.

• Consider a cosigner. You may be able to add a family member or friend to your application as a cosigner to help you improve your chances of landing a loan to improve your credit. They will 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 of utility bills and subscription services to your credit history, which may help your credit score.
• Become an authorized user. Parents can sometimes add their teenage or college-aged children to a credit card 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 credit score.

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. When you are ready to find an option that fits your needs, look for the interest rates and terms that will be most favorable for you.