‘The industry believes that poor credit scores are self–inflicted’: A new wave of fintechs is giving the underbanked access to credit
- New fintechs are targeting underserved communities that don’t have credit histories, using new methodologies to help them build credit scores.
- As more Millennials and Gen Zers navigate their financial journeys, their participation in the credit system could increasingly be aided by such fintechs.
In recent years, there has been a growing number of fintechs aiming to make credit more accessible to consumers. The industry has seen a number of companies targeting underserved communities that don’t have credit histories, using new methodologies to help them build credit scores.
There is a large population in the US that needs better access to financial services. Around 18% of the US consumer market is either underbanked (13%) or unbanked (5%), according to the newest Federal Reserve study on 2020 data, similar to previous years.
While the unbanked represent people with no bank accounts, the underbanked have bank accounts but use alternative financial services (money orders, payday loans, pawn shop loans, etc.) that appear to have been insufficient to meet their financial needs.
And despite still experiencing financial hardship, with studies showing that a quarter of Americans have no emergency savings at all, people haven’t been turning to credit in the same way as before. Only 37% of adults applied for credit in 2020, a significant decline from the 41% who applied a year before, the FR study showed.
The pandemic has deteriorated the relationship between borrowers and credit card issuers due to increased financial stress, lack of responsiveness, and misaligned terms and rewards, according to the J.D. Power 2021 U.S. Credit Card Satisfaction Study. Overall customer satisfaction declined last year, led by midsize issuers that struggled to connect with evolving customer needs in a volatile economy.
Considering this new post-pandemic reality which is building on top of an already difficult financial system, more Americans need access to better financing. And in the US, if you don’t have a good credit history, it’s very difficult to get credit cards or loans that don’t seek astronomical interest rates on debt.
A Bankrate study showed that 21% of U.S. consumers got rejected for a credit card in the middle of the coronavirus pandemic because the lender deemed their credit score too low.
This is where these new fintechs are aiming to help. They are offering more accessible credit cards for those who would traditionally get rejected, and coming up with ways to improve credit scores without creating debt.
The missed opportunity
The credit industry has been ripe for disruption for some time, and the idea of looking beyond credit scores and using alternative ways to determine creditworthiness is not new. But what seems to be a new trend in tackling this issue is fintechs coming up with new ways of building credit – either by reducing the chance of creating more debt, or avoiding debt altogether.
And it seems that fintechs are doing this because the incumbent industry is taking too long. TomoCredit founder and CEO, Kristy Kim, initially wanted to build an underwriting solution that would give immigrants or people without credit scores access to lending products, and license it out to the banks. She then realized that her plan might have been too optimistic.
“The big banks agreed with me that it's a big pain point for younger consumers who don't have a credit score, and that they’re missing out on those high potential customers. They knew the problem, but they weren’t eager to work on a solution. That encouraged me to solve this problem on my own instead of waiting for the bank to come up with a solution in, who knows, 5 to 10 years?” Kim told Tearsheet.
Kim went on to build TomoCredit, which welcomes applicants without credit scores as it works independently of FICO. Since launching during the pandemic, TomoCredit has recorded more than two million applicants, raised $20 million in funding, and has grown its revenues tenfold.
Its target customers are Gen Z and Millennials, as they’re more willing to try a fintech product rather than go to a bigger bank, said Kim.
“They're looking for the next cool product in finance. I think that helped us during the pandemic because we don't have any branch – we are 100% online. Our customers don't go into the bank, they just sign up for Tomo on their mobile app or online.”
This echoes the experience at Petal, another fintech that wants to help underserved communities get access to credit. Its members are largely younger, digitally-native consumers who are just entering the credit market, coming in after being rejected by the traditional industry, according to CEO Jason Gross.
More than 40% of new approved members for a Petal card in 2021 were first denied credit by a major bank, and the majority of cardholders had little or no history when they first applied for a Petal card.
Moreover, members who joined with no prior credit history were able to build an average credit score of 676 — a healthy score that can qualify them to get other lending products such as auto loans and mortgages.
And this model is proving to be successful: Petal tripled its user base and more than quadrupled its revenue last year, from $11 million to nearly $50 million, according to reports. The company now has nearly 300,000 cardholders, adding 10,000 to 20,000 new members per month, according to Gross.
This shows the appeal of fintechs that are unlocking financial opportunities previously out of people’s reach. This has actually been the mantra behind building these companies – to help underbanked consumers get access into the system.
But why has it taken so long for the industry to provide access to credit to a broader demographic? One big reason is that credit scores are believed to be a direct result of someone’s spending habits, and don’t take into account the wider economic issues that affect one’s financial life.
Changing people’s perceptions around whether the wider demographic “deserves” credit is the first hurdle, according to Neal Desai, CEO at Kafene, a fintech company that wants to help the 100 million-plus underbanked U.S. consumers at the point of sale by providing flexible financing.
“The industry generally believes that poor credit scores are self-inflicted. That narrative is compelling but ultimately false. If you look at the data, the primary cause for poor credit scores is not enough income – the system currently results in nearly half the population not making ends meet despite their best intentions,” Desai told Tearsheet.
A new model
Another issue when underwriting for “new” demographics is data accessibility, added Desai. He argued that the FICO credit score system is not as predictive for underbanked consumers as most of them have never borrowed, making it a challenge to create a safe way to finance people that have had restricted access to financial products.
“Without a uniform standard that can be trusted, many players are paralyzed because they don’t know how to underwrite this consumer base. Companies like Kafene have invested millions of dollars in creating models that work, but we are the exception rather than the norm,” Desai said.
Kafene's financing platform allows consumers to access funds to purchase appliances, electronics, furniture, and other goods at participating retailers across the U.S. The company’s mission is to extend credit-like services for people to build credit on flexible terms without creating debt, as payments are made regularly from customers’ linked bank accounts. It recently got a $75 million capital injection to scale its retail footprint and expand the delivery of its financing platform.
The company offers consumers interest-free BNPL options as well as flexible lease-to-own options, both of which can help with improving their credit scores as the company reports good credit behaviors to Equifax and Experian. And if a customer can’t make their payments, they can cancel their agreement and their credit score won’t be negatively affected. Plus, Kafene accepts the goods back.
At TomoCredit, a user’s credit card gets paid every week from her own debit account, and if a weekly payment is missed, the card is temporarily frozen and cannot be used until that payment is made. Plus, the weekly payment frequency helps with improving credit scores faster, incentivizing customers to pay off their balance.
Petal also uses cash flow underwriting to help people build credit, analyzing banking history to determine creditworthiness by taking into account a person’s income, spending and savings. It developed a proprietary cash flow underwriting technology, Cash Score, to evaluate a consumer’s income, assets, savings, transaction history, and financial volatility, to make underwriting decisions.
It also launched a sister company of sorts early last year called Prism Data, a B2B API that allows other businesses and verticals to access Cash Score to help them make better decisions.
“The credit score of the future will be a complete, real-time and holistic assessment of a consumer’s financial position, including their income, cash flows and assets, in addition to debt and repayment history. Prism Data exists to give financial providers the tools they need to create next-generation products and capabilities,” Petal’s CEO Gross told TechCrunch.
Petal is nearing unicorn status - a few weeks ago it announced that it has raised a $140 million Series D round of funding, bringing its valuation to $800 million.
There’s also Credit Karma, which recently launched Credit Builder in partnership with financial health platform SeedFi. When someone signs up for Credit Builder, it opens a line of credit through SeedFi without a credit pull.
The customer can then choose how much they wish to contribute toward their savings goals on a weekly, biweekly or monthly basis. This establishes a pattern of timely payments which is reported to the credit bureaus by SeedFi to help customers improve their credit score.
Members can track their progress over time, including the number of payments made, amount saved and total score improvement, all within the Credit Karma app. Credit Builder is free and does not charge monthly fees or have an APR.
“Most consumers with lower credit scores don’t have the chance to prove to lenders that they can be a good borrower, making it more difficult to get approved for credit and making it more costly to borrow. That’s why we launched Credit Builder, in partnership with SeedFi. Together, we want to give these members a free, low-risk way to prove they can borrow responsibly, while helping them build their credit and save money.” said Poulomi Damany, GM of Assets and Tax at Credit Karma.
As more Millennials and Gen Zers navigate their financial journeys, their participation in the credit system could increasingly be aided by such fintechs. After all, the two generations have the lowest credit scores and, consequently, are the most interested in getting that number up.
But another demographic also has lots to gain from fintechs that are targeting the credit score arena: immigrants.
As credit history typically stops at the border, many people who move to the US from abroad have to build consumer credit from scratch. Nova Credit partnered with American Express to address this problem and created an alternative score to assess foreign residents’ creditworthiness based on their home country credit data. It can also be used for Americans returning to the country after years working abroad.
Despite the complexities of the US’ credit system, there seems to be a big influx of fintech companies looking to address the disadvantages faced by different demographics. And while this newly formed sub-sector of the credit industry is still in its nascent stages, it has certainly brought more attention to an important issue faced by many.