Key learning points
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Credit-building products, such as credit-building loans and secured credit cards, can help individuals with limited credit history build their credit.
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Credit building apps can also be useful tools for improving credit, by offering services such as credit tracking and education.
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It’s important to carefully consider your options and choose the best credit building tool for your needs and financial situation.
If your credit score is low or you don’t have one, a credit-building loan can help you raise your score or get you started on building a credit history. By learning the features of different types of credit building services and products, you can choose which one is best to help you build your credit.
Credit building products to improve your score
Credit building products give you the chance to prove to lenders that you can manage your debt. You typically borrow a small amount and make payments that are reported to credit bureaus to establish a credit history. They are easier to obtain than traditional credit cards or loan products.
However, interest rates are often higher for shorter repayment terms, which can make payments difficult to process. Some options require you to use your money upfront or wait to access the credit until you have made several payments on time.
The most common credit building products are credit building loans, small dollar loans, secured credit cards and credit building apps. Choosing the right product can put you on the path to low personal loan rates in the future.
Credit builder loan
Credit-building loans require you to make some or all of your monthly payments before you receive any money. If approved, the lender deposits the loan amount into a secured savings account. Each payment is reported to at least one of the three credit bureaus, which helps build your credit history and, ideally, your credit score.
Once you have made a certain number of payments, the lender can release some or all of the money after deducting any interest charges or fees. You’re normally limited to borrowing between $300 and $1,000, although some lenders may set limits as high as $3,000. In most cases, the repayment period is between 12 and 36 months. The shorter the term, the higher your monthly amount, but the less interest you pay.
Who is it best for:
Credit-building loans are best if you have little to no credit history and don’t need the loan money immediately.
Small dollar loan
As part of the Consumer Protection Act, the Small Dollar Loan Program (SDLP) offers a cheaper alternative to bad credit loans, payday loans, and check cashing businesses. One of the other benefits of a small dollar loan is that they must be reported to at least one credit bureau. They can also be a credit-building tool.
Small dollar loans must meet the following standards:
- Be no more than $2,500.
- Will be repaid in installments.
- No fines for prepayment.
- Reported to at least one of the three credit bureaus.
- The APR may not exceed 36 percent.
- Meet all other affordability requirements as required by the financial institution.
You can get a small dollar loan from select national and community banks and local credit unions. They work in the same way as a traditional loan, in that you repay the lump sum balance in installments. The fees are typically charged as a flat fee based on the amount you borrow.
Who is it best for:
Small dollar loans are best for borrowers who have little to no credit and need a smaller loan amount and want to avoid an expensive loan.
Secured credit cards
A secured credit card is a credit card for which you use your own money as collateral. You give the lender cash for the amount you want to secure, and the lender extends that credit to you.
For example, if you want to get a $200 secured credit card, you will need to transfer $200 of your money to the secured credit card issuer. The lender will then give you a credit worth €200, which you can use just like a regular credit card.
Interest rates and fees are often very high, but your payments and balances are reported to the credit bureaus so you can establish a payment history. Secured credit cards are often easier to qualify for than regular credit cards because you are essentially giving the lender the money that they then lend to you.
This can also help you improve or establish your credit utilization ratio, which measures how much of your available revolving credit is being used. If you keep your credit utilization exceptionally low or pay off the balance in full each month, you could see a significant increase in your credit scores.
Who is it best for:
Borrowers who have extra money to set up a credit account and want to build a payment history on a revolving line of credit.
Credit building apps
There are credit building apps to help you build your credit. Some apps offer credit tracking services, while others offer educational tools to help you build (and maintain) your credit.
In general, you will come across three types of apps:
- Credit monitoring services that offer suggestions on how to improve your score.
- Credit building lenders that offer credit building loans and small dollar loans.
- Credit reporting services that help you improve your credit rating through alternative reporting.
Who is it best for:
Borrowers who are comfortable using a mobile app and those looking for a comprehensive approach to improving their credit.
Advantages and disadvantages of credit building products
Just like with any other financial instrument, there are drawbacks to be aware of when it comes to credit-building products. Knowing the pros and cons of credit-building products can help you determine which ones best suit your credit improvement goals.
Plus points
- It is easier to get approved than for other credit products.
- Can help you build your credit history and improve your score.
- Can help you establish a credit score if you don’t have one.
- A better score can lead to lower rates and conditions in the future.
Cons
- You may need cash up front or a proven payment history before receiving any money.
- Most products have small borrowing or credit limits.
- Short terms and high rates can make payment unaffordable.
How to Choose the Best Credit Building Tool
The best credit-building tool depends on your savings situation, how quickly you need the money, and how much money you need.
| A credit-building loan is best if: | A small balance loan is best if: | A secured credit card is best if: |
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Best practices for building credit
- Pay your bills on time. Regardless of the type of credit-building loan you take out, your credit score will drop if you don’t make payments on time. Keep an eye on them by scheduling reminders or using autopay.
- Keep your credit card balance low. Besides late payments, the fastest way to weaken your credit score is to max out revolving debt like credit cards. In general, avoid using more than 30 percent of your available credit. For example, if you have access to $1,000 in total credit, don’t use more than $300 in any billing cycle.
- Investigate alternative credit reporting options. You can add timely household bills or subscription services that you use regularly to your credit report to improve your score. For example, Experian Boost lets you add up to two years of payment history for utility bills or streaming services to your credit report, which can boost your scores.
- Find a co-signer. Some creditors let you add someone else’s credit and income as a cosigner so you qualify for a new account. They will confiscate the account if you cannot pay it back. So make sure everyone understands the responsibilities before choosing this option.
- Ask to be an authorized user. Ask a parent or relative if you can be added as an authorized user. This is a common way for teens or students to generate a credit score. Be sure to discuss the rules for using the card to avoid misunderstandings, especially since misuse of the account will have consequences for both of you.
