Credit building products (CBPs) are any loan or payment card whose purpose is to improve consumer credit ratings. They use a combination of collateral, alternative creditworthiness metrics, and debit-to-credit transaction swapping to accept borrowers with subprime credit at non-predatory APRs (under 36%). CBPs are essential components of credit builder programs.

The most common CBPs are credit builder loans, credit builder cards, and secured credit cards, as well as credit builder accounts, savings-secured loans, and rent-reporting services.

CBPs have lower eligibility criteria than consumer financial products such as mortgages, but they avoid predatory APRs (≥36%) common to payday loans and title loans.

Credit builder products do not include debt consolidation loans, which are debt payoff tools that combine two or more card and loan debts into a single installment.

Summary

Definition

Credit building products are loans and cards that use a combination of alternative creditworthiness metrics and collateral to accept borrowers with zero or damaged credit profile.

Collateral a Key Driver

Collateral drives the favorable terms associated with credit builder products. Collateral is cash or a physical asset borrowers pledge to mitigate the lender's risk. Lower risk allows lenders to offer flexible eligibility criteria, low interest rates, and, in some cases, lenient late payment terms.

Collateral can be pledged upfront or progressively over the life of the loan or card. Responsible use, such as consistent on-time payments, can earn back the collateral without eliminate favorable interest rates.

As borrowers build demonstrate reliability and consistency, they earn the respect and trust of lenders.

#1 Credit Builder Loans

Credit builder loans (CBLs) combine collateral, deferred distribution, and alternative creditworthiness metrics to provide flexible eligibility criteria and low interest.

There are three types. Payment-secured CBLs postpone principal distribution until the end of the loan term and require borrower make installment payments to secure the loan progressively over time.

Unsecured CBLs distribute principal upfront like traditional loans but use alternative credit worthiness metrics to accept consumers with subprime credit at APRs less than 36%.

Fully-secured CBLs require the borrower deposit the full value of the loan upfront into a secured account. The lender either draws payments from that account or requires the borrower make normal payments, the latter of which is a structure often referred to as savings-secured loans.

#2 Savings-Secured Loans

Savings-secured loans (SSLs)—also known by various names such as "share-secured loans," "certified loans," "pledge loans," "certificate-secured loans" and "passbook loans"—are a popular type of fully-secured credit builder loan. In this type, the borrower pledges savings as collateral for a loan.

This collateral, which is locked for the duration of the loan, procures low interest rates for the borrower. Many savings-secured loans provide nominal interest on the saving held in collateral.

The structure is counterintuitive because the borrower is not cash-strapped yet chooses to pay interest on a loan rather than use existing funds.

There is no benefit to using savings-secured loans for funding purposes. The borrower using savings rather than the loan will not pay interest, and a borrower who defaults on the loan forfeits the savings anyway.

Borrowers nevertheless finance with SSLs because of a psychological bias called the endowment effect, which states that people feel attached to things they own (their savings) enough to pay for something they don't need but don't own (the loan with interest). A popular study shows young adults willing to pay $5 for a coffee mug but refusing to part with it for $15.

Despite the endowment effect, responsible use of savings-secured loans leads to credit improvements that lower future debt interest and save the borrower money in the long run.

In other words, savings-secured loans are excellent credit building products, but not financing tools.

#3 Credit Builder Cards

Credit builder cards (CBCs) are payment cards whose purpose is helping consumers with subprime credit improve their profile. They are NOT the same as secured credit cards, but some normal credit cards can be credit builder cards. There are at least 18 credit builder cards on the market today.

Credit builder cards are characterized by flexible acceptance criteria, forgiving late payment rules, debit-to-credit transaction swapping, customizable limits. Some lenders even provide 0% interest and no late penalties as long as you open a banking account with them.

In a word, credit builder cards are lenient.

It's important to note that credit builder cards never require security deposits. That's what secured credit cards for (but we don't know why anyone would get one).

For example, Zolve allows you to use a card like a normal debit card — drawing only on funds you have in your account — then reports those payments as credit transactions. Voilà. Credit building with no risk.

#4 Secured Credit Cards

Secured credit cards require the borrower deposit cash into a collateral account that's recoverable after approximately 6 months (average) of responsible use. The reimbursement of collateral is called graduation and is usually at the lender's discretion. Some lenders are unfortunately known for postponing graduation indefinitely.

Secured credit cards have two distinct disadvantage compared to other credit building products. First, they require collateral upfront that they have no obligation to reimburse. Second, they charge high interest rates despite the collateral.

Collateral limits risk, which means high interest rates are unacceptable. Secured card lenders with high rates benefit from controlling the market and making often empty promises to graduate the card to unsecured status.

#5 Credit Builder Accounts

Credit builder accounts refer to distinct registries that record transactions from other credit builder products such as loans and cards within a lender's database. It is the account, and not the product, that gets reported to credit bureaus.

Our surveys reveal that consumers often interpret loan proceeds as the agreement, but the reality is that underlying accounts recording transactions are the object of credit reporting and building.

Credit builder accounts are important because they're responsible for communication with the credit bureaus (TransUnion, Equifax, Experian), and they do not always report.

For example, some credit builder loan accounts only report one bureau. Moreover, some lenders may not record late payments on an account even though they occur on the loan.

Borrowers who want to build credit must understand what happens in the underlying credit builder account. Good credit builder programs ensure maximum payment flexibility and positive reporting on account.

#6 Rent Reporting Services

Rent reporting services, or more generally, bill reporting services, communicate payments that otherwise go unnoticed to credit bureaus and improve payment history on consumer credit reports.

These are the weakest credit builder product, but they have minimal risk and enable consumers to benefit from payments they already make.

Traditional Loans & Credit Cards

Traditional loans such as mortgages and unsecured personal loans, as well as high value credit cards, can improve consumer credit ratings with the same responsible use as credit builder products.

The difference is that credit builder products typically offer lower rates (always under 36% as a reference for predatory interest), so consumers with thin credit profiles should prefer installment credit builder loans until their credit is good enough to attract low rates.

In other words, consumers can use credit builder products to improve their profile to a point where the interest they save on traditional loans and cards pays for low-interest credit builder interest hand-over-fist.

This progression can be likened to a reputation in which consumers establish trust with small actions (credit builder products) in order to reap the rewards of harmonious collaboration (low rates from banks) and even earn the favor of creditors (high limits, quick distribution, and attentive customer service).