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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

Background and Context

Study Setting

Research conducted with St. Louis Community Credit Union examining their Credit Builder Loan (CBL) program which has originated over 4,400 loans since 2009.

Sample

Study included over 1,500 credit union members who expressed interest in CBLs, with nearly 20% lacking a FICO® Score at baseline.

Methodology

Randomized encouragement design comparing a standard CBL arm versus an "Extra Step" arm requiring financial education, with credit outcomes tracked over 18 months.

CBL Take-up Rates Show Strong Impact of Extra Requirements

  • The standard CBL arm had 30% take-up within 18 months
  • The Extra Step arm had only 12% take-up, showing financial education requirements significantly deterred participation
  • Demonstrates how additional requirements can create barriers to credit-building products

Differential Effects of CBL Based on Existing Credit Activity

  • Those with less installment credit activity saw +15 point increase in credit scores
  • Those with more installment credit activity experienced -17 point decrease
  • Shows CBLs can have opposite effects depending on borrower's existing credit profile

High Delinquency Rates on CBLs

  • Approximately 40% of CBL users made at least one payment more than 30 days late
  • Higher delinquency rates among those with existing installment loans
  • Indicates CBLs may overextend some borrowers despite modest payment amounts

Credit Score Visibility Changes Over Study Period

  • Nearly 50% of those unscored at baseline obtained a credit score by 18 months
  • Only 4% of those with scores at baseline became unscored
  • Demonstrates CBLs' effectiveness at establishing credit visibility

Positive Selection into CBL Take-up

  • CBL takers showed 11 point higher credit scores than non-takers
  • Selection effect consistent across both study arms
  • Indicates CBLs attract consumers on upward credit trajectory

Contribution and Implications

  • CBLs can be effective for establishing credit but should be targeted to consumers without existing installment debt
  • Credit bureaus should consider reporting CBLs as distinct from standard installment loans to better signal borrower quality
  • Financial education requirements may create counterproductive barriers to credit building

Data Sources

  • Take-up rates from Table 3 Panel A
  • Credit score effects from Table 5 Columns 5-6
  • Delinquency rates from Figure 2
  • Credit visibility from Table 2
  • Selection effects from Table 8