Credit-building loan products have begun to proliferate in the U.S. marketplace. However, there is little evidence on how much these products boost credit scores and for whom. IPA and RAND, a nonprofit global policy think tank, are conducting an impact evaluation of a credit-building loan product offered at a credit union in Missouri, both alone and coupled with financial counseling. In addition, this study evaluates a product add-on designed to help these borrowers save.
Policymakers, financial institutions, and consumer advocates are increasingly pointing to the importance of good credit as an asset. Not having credit, or having a poor credit score, affects one’s ability to obtain housing, buy a car, or even gain employment. A lack of credit can thus act as an additional tax on the poor. Yet building credit can be a “chicken and egg” challenge; credit is needed to build a credit history, but it is hard to get access to credit without a credit history. In response to this challenge, credit-building loan products have begun to proliferate in the marketplace, usually offered by financial institutions with a social mission. However, there is little evidence on how much these products boost credit scores and for whom. Moreover, there are questions around the long-term effects of credit-building loans: once consumers improve their credit through a credit-building loan, are they equipped to use it to their benefit? Are clients who voluntarily choose a credit-building loan better equipped to use credit to their benefit, compared to those who don’t choose such products? Additionally, does consumer education improve the impact of credit-building loans? This study aims to answer these questions.
Millions of Americans have poor credit or little credit history. The Corporation for Enterprise Development (CFED) estimates that 56 percent of Americans have “subprime” credit, with low-income Americans particularly affected.1 Credit building loans, secured credit cards, and other low-risk forms of “revolving credit,” which is automatically renewed as debts are paid off, are often pointed to as credit-building solutions, but little is known about the long-term, or even short-term, benefits of these approaches.
A credit union in Missouri is interested in understanding how much a loan product designed to boost credit improves borrower credit scores. This study targets low-income clients of the credit union who have poor credit or limited credit history.
This study will evaluate the impact of a credit-building loan product offered at a credit union in Missouri on credit union members’ credit, savings, and overall financial health in the short and long term, that is, one year and four years after receiving the loan. It will also test the impact of over-the-phone financial counseling, both with the loan and without it, and test the impact of a product add-on designed to help borrowers save.
With the loan, the credit union lends the client $600 and puts it into the client’s savings account, with clients’ access to this money initially restricted. With each monthly payment of roughly $54, $50 of the $600 is made available, unrestricted, in the client’s savings account. On-time payment of the loan product is reported to the three credit bureaus with the intent of building credit scores. Over-the-phone financial counseling, which covers credit and credit-building, will be offered to some borrowers.
IPA and RAND will enroll credit union members in the study in five branches, inviting them to first take a survey if they are interested in improving their credit. At the end of the survey, surveyors will describe the loan product to respondents and ask if they are interested in taking it up. Depending on the respondent’s interest in the product, computer software will be used to randomly assign the member to one of the following groups:
(1.) Clients not expressing interest in the loan and not offered phone financial counseling
(2.) Clients not expressing interest in the loan and offered phone financial counseling
(3.) Clients expressing interest in the loan and encouraged to open loan right away; not offered phone financial counseling
(4.) Clients expressing interest in the loan and encouraged to open loan right away; offered phone financial counseling
(5.) Clients expressing interest in the loan and not encouraged to open the loan right away (must complete online financial education before opening the loan); not offered phone financial counseling.
(6.) Clients expressing interest in the loan and not encouraged to open the loan right away (must complete online financial education before opening the loan); offered phone financial counseling.
In addition, this study will evaluate a product add-on designed to help customers save, called Pay Yourself Back. After a client’s loan is repaid, this product add-on initiates monthly transfers of the amount of money that was going into paying off the loan (or a portion of this amount) into a savings account. To test the impact of this product, a random half of the participants who decide to take up the loan will also be offered the add-on. The other half of borrowers will serve as the comparison group.
Researchers designed the automated savings product, whereas the loan and the financial counseling curriculum were both pre-existing products. To measure outcomes, the research team will use credit report data, credit union administrative data, and information gathered from surveys.