Types of credit-building products and how to use them

If your credit score is low, or if you don’t have a credit score, there are credit-building tools and products available to help turn things around. From credit builder loans and secured credit cards to educational credit building apps, there’s a variety of choices to help boost your credit score or establish a credit history. Each credit-building product works differently, however, so review your options carefully to choose the best option for 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, they may be easier to get approved for than traditional credit cards or loans.

Despite how useful they can be, the interest rates are often higher with shorter repayment terms, which can make your payments tough to handle. Some options may also require you to deposit money or wait to access the credit until you’ve made several payments on time.

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

Credit-builder loans

Credit-building loans require you to make a portion of or all of the monthly payments before you receive any funds. 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 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, though some lenders offer terms up to 60 months. Paying the loan off ahead of schedule can actually be counterproductive because it defeats the purpose of taking a credit-builder loan. While you may save on interest, you won’t benefit from the on-time payments being reported on your credit report, which should help improve your credit score. If you pay off the loan too quickly, then you’ll be reducing the opportunity to establish a positive payment history, which makes up 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

A small personal loan will also help build your credit — without making you wait for funding. Interest rates can be higher, especially if you need to turn to bad credit loans, but it can help you build a positive payment history just like a credit-builder loan.

You can also look into loans offered by a Community Development Financial Institution (CDFI) in your area. These frequently provide small loans to borrowers who may not have access to other forms of credit. As part of the Consumer Protection Act, the Small Dollar Loan Program (SDLP) incentivizes certified CDFIs to provide a cheaper alternative to bad credit loans, payday lending and check-cashing companies.

Small-dollar loans must be no more than $2,500. One of the primary benefits of a small dollar loan is that it must be reported to at least one credit bureau. And like other 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. The fees are typically charged as a flat fee based on how much you borrow.

Who it’s 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 a high-cost payday loan.

Secured credit cards

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 grants you that much credit.

For example, to get a $200 secured credit card, you’d transfer $200 from your funds to the secured credit card lender. The lender would then give you $200 worth of credit, which can be used just like a regular credit card.

Interest rates and fees are often very high, but your payments and balance are reported to the credit bureaus, helping you to establish a payment history. 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.

This can also help you improve or establish your credit utilization ratio, which measures how much of your available revolving credit is used. If you keep your credit card usage exceptionally low or pay the balance off completely each month, you can see a significant uptick in your credit scores.

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

Credit-building apps exist to help you build your credit. Some apps provide credit tracking services, while others provide educational resources to help you build — and maintain — your credit.

You’ll generally come across three types of apps:

• Credit monitoring services that offer suggestions on how to improve your score.
• Credit-building lenders which offer credit-builder and small dollar loans.
• Credit reporting services that help boost your credit through alternative reporting.

Who it’s best for:

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

Pros and cons of credit-building products

Just like every other financial tool, there are downsides to be aware of when it comes to credit-building products. Knowing the advantages and disadvantages of credit-building products can help you determine the best fit for your credit improvement goals.

Pros

• Eligibility criteria is typically less strict than other forms of credit.
• May improve or build your credit score and history.
• Over time, may help you access lower interest rates.

Cons

• Upfront cash or a proven payment history required for approval.
• Most products have small loan amounts or low credit limits.
• Short terms and high rates may make the payment unaffordable.

Best practices for building credit

• Pay your bills on time. Regardless of the type of credit-builder loan you take out, 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 any 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 account if you can’t repay it, 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. This is a common way for teenagers or college students to generate a credit score. Ensure you discuss the rules for using the card to avoid misunderstandings, especially because mishandling the account will affect both of you.

Bottom line

Several financial products, including credit-builder loans and secured credit cards, can help you build or re-establish credit. The best one for you will depend on your unique financial situation. For example, a secured credit card might be an ideal choice to establish credit using a revolving credit line. However, if you do not want a credit card, it may make more sense to consider taking out a small-dollar or credit-builder loan.

Regardless of your choice, repay the loan on time to ensure you build credit. Missing a payment could harm your credit score and take you further from your goals.