Start your customer credit lifecycle with a graduated credit builder

Low credit scores negatively impact borrowers’ access to credit. It’s only natural that applicants want to improve their scores, and that lenders launch credit builder products to help them. But traditional credit builder loans have presented their own challenges, from underwhelming results to inflating credit scores on risky borrowers.

Perhaps the greatest challenge for providers, though, is what happens when the credit builder works perfectly: the borrower takes their new credit score and takes out a loan or credit card with another lender.

There is a better model, a comprehensive lifecycle based not simply on the credit builder product but on the applicant’s long-term financial goals.

In this article, we’ll explore the purpose of credit builder products, where they fall short, and how a credit builder lifecycle can make them work better for providers, borrowers, and the industry as a whole.

Impact of credit scores

It goes without saying that a low credit score negatively impacts credit opportunities, whether the applicant has bad credit history or just a thin credit file. CFPB data shows that of the 40% of consumers who apply for credit annually, nearly half were rejected, and a similar number never even applied because they figured they would be turned down anyway (see §5.1 on credit applications).

While most Americans have tradelines on record with at least one of the major credit bureaus, millions remain “credit invisible”. Here’s how the numbers broke down in the last CFPB survey:

That’s 45.4 million Americans—nearly a fifth of the population—who lack access to most credit simply because their records are incomplete.

And while we all want to live in a world where everyone has access to credit, we should remember that the milk of human kindness is hardly the only motivation here: Borrowers with thin files represent groups that many lenders hope to capture.

• Immigrants. While the word ‘immigration’ may still conjure the image of Ellis Island newcomers with nothing but the clothes on their backs, the reality is that immigrants are more likely to hold a degree than the native born, and account for 30% of small business growth. Their thin files and low scores are merely a consequence of poor data sharing between American credit bureaus and their international counterparts.
• Young people. As Gen Z rapidly adopts credit cards, their early experiences applying for and using credit may be pivotal steps in forming long-term relationships and loyalty.
• Balance carriers. Less wealthy cardholders are more likely to keep a revolving balance from month to month, securing their providers a revenue stream from interest as opposed to interchange alone.

Credit providers, being motivated to both attract these borrowers and mitigate risk, have developed an ingenious solution: the credit builder loan.

The problem with traditional credit builder loans

When people use credit they’re essentially renting money, buying near-term liquidity in exchange for greater long-term payments. But traditional credit builder products (either secured cards or installment accounts) work differently: Rather than buying near-term liquidity, they’re buying a better credit score and hopefully greater long-term access to credit.

The expectation for a better credit score can lead to problems for both parties.

1. Underwhelming results for consumers. If you promise that scores will go up by X points, borrowers will be reasonably disappointed if their score goes up by anything less. And even if the credit builder delivers on improving a score, it might still fail to increase the borrower’s access to credit, as lenders may be just as unwilling to extend an offer to someone with a 380 credit score as they would someone with a 350.
2. Underwhelming outcomes for providers. When a credit builder loan does work, what’s keeping borrowers from taking their improved score down to any other credit provider? If a provider treats their credit builder as a loss-leader, then a one-product customer ends up being like the guy who samples every flavor of ice cream but leaves without buying a cone.

And the issues don’t end with the two parties involved in the transaction: they extend into the broader credit ecosystem as credit builder customers apply for loans or cards elsewhere. As Alex Johnson put it,

[T]he idea that credit builder products designed to never let their users default are a good on-ramp for riskier credit products is easily disprovable. [...] The difficult truth is that such credit builder products aren’t reporting useful signals to the credit bureaus, and savvy lenders are already screening out these credit builder tradelines or treating them as negative signals in their underwriting models.

There’s something of a conundrum here. The financing industry relies almost entirely on creditworthiness. (Even with secured loans, credit providers need the majority of borrowers to repay their debts in full. Recovering and auctioning assets might soften the blow of a default, but it’s not a profit center.) But the tools we have for measuring creditworthiness (credit scores and some alternative metrics) are imperfect, and the tools we have for building creditworthiness leave providers and consumers wanting.

If a credit builder product is going to work for providers, consumers, and the rest of the industry, it needs to be more than a quick bump to a FICO score. It needs to be the first step of a larger lifecycle, allowing borrowers to build creditworthiness and increase their access to credit—all with the same provider.

Enter the graduated credit builder.

Graduated credit builders and the customer lifecycle journey

What separates a graduated credit builder from other credit building loans isn’t the financial terms of the product itself, it’s where it sits within a customer’s lifecycle with the credit provider. The model recognizes that consumers don’t want higher credit scores in and of themselves, but as a means to an end: greater access to credit.

It’s built with that next product in mind, with the credit builder feeding naturally into the next loan, card, or line of credit. Rather than focusing on the credit score, it aims to build steady and reliable repayment habits.

A lifecycle of connected credit products

Here’s how that lifecycle could look:

1. Application and product matching. A borrower might have sought out your credit builder product, or they might be interested in another product they don’t yet qualify for. In either case, you can offer them the credit builder as a pathway to better lending products, asking what their near- and mid-term financial goals are and showing them a pathway to it.
2. Payment and servicing. Reporting to the credit bureaus gives them a strong incentive to make on-time payments, but there are also steps you can take to help nudge them toward repayment throughout the duration of their credit builder—without creating the impossible-to-default products that don’t build creditworthiness. SMS payment reminders, grace periods, and automatic payments all help borrowers stay on top of their payment schedule.
3. Secured and partially-secured products. Throughout their credit builder product, the payments a borrower makes can go into a restricted deposit account. Those deposits can then be used as collateral for a secured credit product. And as borrowers continue making on-time payments and demonstrating creditworthiness, you can expand their credit limits beyond the amount in the deposit account, gradually increasing their credit limit into partially secured loans and lines of credit.
4. Unsecured credit. A borrower might demonstrate creditworthiness long before their credit score reflects it. But a credit provider who’s built a relationship with them will be able to recognize and trust those borrowers earlier, offering them better unsecured credit products than competitors.

And bear in mind that this outline leaves a lot of room for specialization (like focusing on card, automotive credit, or small business lending) and personalization.

Create a credit ecosystem

Maybe you’re interested in the idea of a lifecycle journey, but not sure about expanding into other markets or product models. It might suit you better to specialize in a single area, but that doesn’t mean you have to abandon the idea of a lifecycle journey altogether. Instead of providing each step of the credit lifecycle on your own, you can partner with likeminded providers to create a credit ecosystem.

One provider specializing in credit builder products and subprime borrowers can be the starting point of the credit lifecycle, and another can offer products further down the line, like installment loans or unsecured lines of credit. Other partners could even specialize in niche areas, like automotive or debt consolidation. Interconnected through open banking, these providers could expand borrowers access to credit while maintaining their own individual risk appetites.

When an applicant comes to any one of these partners looking for credit, they can simultaneously be underwritten for any number of complementary products, and graduation from one product can blend seamlessly into a referral for the next partner. You get a steady stream of referrals, and your borrowers have access to credit without the loopholes.

Secured credit as a preventive measure

Collateral isn’t only useful to credit providers as a last resort when borrowers default; it’s in fact far more valuable as a preventative measure than a reactive collections strategy. The simple knowledge that a lender could repossess their collateral is enough to keep many borrowers repaying. (We discussed these trends in our most recent compliance newsletter, noting that credit secured by vehicles and homes see delinquency rates less than half of those for unsecured credit.)

As delinquency and default rates rise nationwide, secured and partially-secured credit options help credit providers mitigate risk while still extending opportunities to borrowers who would otherwise be denied credit. And while a loan could be secured with anything from car titles to a cryptocurrency, a card or loan backed by a cash deposit is far easier to implement, and poses fewer risks and challenges for recovery.

Implementing a credit lifecycle

Offering a credit lifecycle offers several benefits over a line of disconnected products. A lifecycle improves the customer experience, as applicants are directed towards products that match their risk level and repayment ability, rather than being turned away.

As they repay their initial product and graduate into the next, they get a cohesive experience, driving long-term retention from product to product. And as they graduate, lenders can ‘acquire’ new customers for each product without repeating the steps and costs associated with their normal acquisition and underwriting process.

But successfully implementing credit builder products as part of a credit lifecycle also requires some additional considerations, particularly in underwriting and customer interaction.

Underwriting for credit builder products and lifecycles

Providing credit to the credit invisible doesn’t mean you should just throw underwriting out the window. For one, anti-money laundering (AML) and know your customer (KYC) laws require a degree of due diligence and identity verification.

But underwriting with alternative data can also help you identify borrowers who are already able to repay, and have significant histories of making on-time payments for utilities, rent, and other recurring charges that are seldom reported to the credit bureaus. Similarly, cash flow underwriting examines borrowers based on their typical earnings and expenditures, rather than credit history. While these applicants might still benefit from credit builder products, providers could also extend them unsecured and partially-unsecured credit without introducing too much risk.

On a legacy platform, gathering and assessing alternative data would pose significant logistical challenges, possibly negating the value it provides underwriters. But modern platforms with streamlined data tools can decrease the cost of collecting and analyzing alternative data sources, making them a more viable underwriting tool.

Teaching better behavior

A credit provider’s fiduciary responsibility is to make money, not teach financial literacy. But if teaching financial literacy brings tangible results in repayment, then it might be in lenders’ best interest to teach their borrowers, either through traditional education tools or through integrated repayment reminders.

One LoanPro client, for example, has incorporated financial literacy lessons into their card program. As borrowers take lessons and make on-time payments, their credit limit is expanded and interest rates go down. Even credit invisible applicants can get access to their lowest credit limit, and soon build both their credit scores and liquidity as the card program expands with them.

Everyday interactions with borrowers also introduce opportunities for financial education and building long-term retention. Along with a TILA disclosure, lenders might include information about the next products in their credit lifecycle, which borrowers could graduate into after their current product comes to a close. Similarly, due date and grace period reminders can be personalized with information about how missed payments will impact credit scores, helping borrowers recognize the long-term effects of missed payments.

Methods like these can teach better repayment behavior without ‘forcing’ on-time repayment. A product that makes defaulting impossible is a weak signal for future repayment, but a product that boosts creditworthiness by teaching better repayment habits is a viable signal for both the provider who extended the product as well as the rest of the industry.

Launch your credit builder lifecycle on a modern platform

Viewing your products as part of a holistic lifecycle opens your operation up to new avenues for growth, retention, and risk reduction, transforming one-time transactions into long-term customer relationships. But implementing those changes in underwriting, product configuration, and day-to-day operations is by no means simple, especially on legacy platforms or rigid software tools that lock you into their idea of how your portfolio should work.

LoanPro’s modern credit platform offers an end-to-end solution for launching and supporting your credit lifecycle. Capable of handling virtually any class of credit product, LoanPro can streamline the graduation process and help reduce credit losses by an average of 38%.

If you’re interested in launching or revitalizing a credit builder program, reach out to us. We’d love to discuss your ideas for a product lifecycle, and show you what’s worked for other LoanPro clients.