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Credit Building or Credit Crumbling? A Credit Builder Loan's Effects on Consumer Behavior and Market Efficiency in the United States

Journal: Review of Financial Studies

Date: 20230401

Author: Burke, Jeremy; Jamison, Julian; Karlan, Dean; Mihaly, Kata; Zinman, Jonathan

Abstract:
A randomized encouragement design yields null average effects of a credit builder loan (CBL) on consumer credit scores. But machine learning algorithms indicate the nulls are due to stark, offsetting treatment effects depending on baseline installment credit activity. Delinquency on preexisting loan obligations drives the negative effects, suggesting that adding a CBL overextends some consumers and generates negative externalities on other lenders. More favorably for the market, CBL take-up generates positive selection on score improvements. Simple changes to CBL practice, particularly to provider screening and credit bureau reporting, could ameliorate the negative effects for consumers and the market.

Link: Google Scholar

Key Findings

Null Average Effects Mask Important Heterogeneity

While Credit Builder Loans (CBLs) show null average effects on credit scores, significant heterogeneity exists based on baseline installment borrowing activity.

CBL Impact Varies by Prior Credit Status

Consumers with less installment activity at baseline see positive effects, while those with more existing installment debt experience negative outcomes.

Strong Positive Selection Effects

CBL take-up provides valuable market signals - those who choose CBLs show improved creditworthiness independent of the CBL itself.

CBL Take-up Rates by Study Arm

  • CBL Arm had 30% take-up rate within 18 months
  • Extra Step Arm had only 12% take-up rate
  • Financial education requirement significantly reduced take-up

Credit Score Treatment Effects by Baseline Installment Activity

  • Bottom tercile sees +15 point increase in credit score
  • Top tercile experiences -17 point decrease
  • Treatment effects diverge significantly based on prior installment credit activity

Delinquency Rates on CBLs

  • 40% of CBL users had at least one payment 30+ days late
  • High delinquency rates suggest CBLs can backfire for some borrowers
  • Payment difficulties particularly pronounced for those with existing installment debt

Contribution and Implications

  • CBL providers should consider screening based on existing installment debt levels
  • Credit bureaus could improve market efficiency by reporting CBLs as a distinct category
  • Product-linked financial education requirements may be counterproductive for take-up
  • Results highlight importance of considering heterogeneous effects in credit-building product design

Data Sources

  • Take-up rates derived from Table 3 Panel A showing first-stage effects
  • Credit score treatment effects based on Table 5 showing heterogeneous effects by baseline installment activity
  • Delinquency data from Figure 2 sample construction and CBL payment performance