Secure cards from Chime, Varo, GO2bank game credit scores

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About one in six Americans has a credit score below 619, according to the CFPB. Another 23% have too thin a credit history to score or no credit history at all. This puts them in a credit trap: To accumulate credit, these consumers need someone to extend them a line of credit with which they can demonstrate good financial habits. But with scores this low, few lenders are willing to offer them anything.

Neobanks say they can solve the problem with a new twist on secured credit cards. But regulators are already reviewing their offers.

Secured credit cards have been an answer to the problem of restricted credit for decades because they allow subprime borrowers to open a line of credit when they otherwise couldn’t by depositing cash in advance. This sum determines the borrower’s credit limit and gives the banks a guarantee to keep in case of default. However, most require several hundred dollars on deposit and charge high interest rates and fees, which low-income borrowers find difficult to afford.

Refund time?

Neobanks say they can avoid these issues while helping users build credit with secure credit cards that allow customers to pay off their credit balance directly using their deposited money, rather than holding that money aside. . The products allow customers to build credit while paying for day-to-day expenses, neobanks say, without having to save up extra money first.

Chime, Varo and GO2bank describe it as a win-win for consumers and fintechs – consumers can boost their credit rating and neobanks gain loyal customers.

But some in the industry are seeing red flags. “They are, functionally, prepaid credit cards,” fintech analyst Alex Johnson told Protocol. This raises fears that neobanks are helping users boost their credit score with a tool that doesn’t actually indicate their ability to repay. “If I were a lender, I’d be pissed off having to unravel the trade lines in these consumers’ credit files to make sure I’m not extending credit in error to high-risk applicants.”

Secure credit cards from Chime, Varo and GO2bank each have similar mechanics: first, a user transfers money from a checking account to a separate credit account. The amount of money they move determines their credit limit: if a user moves $200 into the credit creation account, they can spend up to $200 on a linked secured credit card. Then, at the end of the payment period, users can pay off their credit card balance with the money they deposited – in this example, that same $200. Varo and Chime also allow users to sign up for automatic payments.

Varo and GO2bank told Protocol that it’s this third step — having to pay off the credit card at the end of the payment period — that makes cards credit cards, not prepaid debit cards. Late payment or non-repayment can harm users’ credit rating. GO2bank additionally charges up to $39 for late payment. Chime declined to answer questions for this story.

With this distinction, neobanks are subject to regulations that govern credit cards but not debit cards, such as the Truth in Lending Act. They can also, crucially, market the cards as credit-creating tools. Businesses earn 1-2% more in trade on credit cards than on debit cards, although pending legislation may reduce this fee.

Visa, on whose network secure credit cards Chime, Varo and GO2bank are issued, did not respond to questions about the similarity of prepaid debit cards. Equifax, Experian and TransUnion also did not respond to questions about whether the cards accurately indicate customers’ ability to repay.

Both Varo and Go2Bank say they aren’t worried about pending legislation changing how much they can charge on interchange because credit-enhancing products aren’t a core source of profit. On the contrary, representatives of both banks told Protocol that the product serves to help them meet customer needs and thus create goodwill with their users. “We’re building deeper connections and deeper engagement,” Raktim Mitra, head of credit cards at Varo, told Protocol.

The CFPB acknowledged Varo and Chime’s secure credit-creation products in its 2021 consumer credit card market report, without mentioning whether the products might merit further scrutiny. When Protocol asked the bureau for an update on its views, a spokesperson said “CFPB is aware of this market development and we are monitoring this issue closely.”

A point of ambiguity

For consumer advocates, the ambiguity around these programs is a symptom of a larger problem: The CFPB has yet to bring neobanks fully under its regulatory responsibility. Under the law that created it, the bureau can oversee financial institutions with more than $10 billion in assets and certain participants in consumer financial markets, such as those working in consumer reporting, debt collection receivables or the servicing of certain loans.

The bureau invoked a dormant authority to investigate non-bank fintechs in April this year, though consumer advocates argued for more regular and thorough oversight. “There is no accountability at this time,” said Rachel Gittleman, financial services outreach manager at the Consumer Federation of America.

Gittleman’s main concern with credit builders is that consumers may not understand that they are using a loan product, despite the terms and conditions spelled out in fine print. Although Chime, Varo, and GO2bank each explicitly market their products as secure credit cards, they minimize possible negative impacts on a customer’s credit, and automatic payment options make the products more like a debit card. ordinary debit that does not present a risk of default. Neobanks, Gittleman warns, have a habit of “marketing the way [they] want the product to be seen rather than what the product is.

Varo and GO2bank representatives disagreed. Mitra de Varo pointed out that customers must have a qualifying deposit of $500 to use the product, which he says helps customers understand that they are signing up for a credit product rather than something entirely. without risk.

Abhijit Chaudhary, chief product officer at GO2bank’s parent company, Green Dot, says the company over-communicates, if at all. “Sometimes we get annoying, but it’s extremely important to make sure our customers know when the invoice is due, what time they need to make a payment, and that we do everything we can so they can at least make a minimum payment and not fall into delinquency,” he said.

“Access shouldn’t be a privilege,” Chaudhary said, citing a common refrain from Green Dot CEO Dan Henry. “Creating credit is a journey and a big business initiative for us – secured credit cards are just one part. We continue to invest. »

Correction: This story was updated on October 5, 2022 to show Varo’s qualifying deposit amount as $500.

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