How neobanks are helping consumers game credit scoring

The CFPB says it is closely monitoring secured credit cards offered by neobanks.

Above the shoulder view of a woman shopping clothes online on laptop, making payment with credit card. Enjoying seasonal sales. Shopaholic concept. Cyber security idea. Close up shot. Laptop screen mockup.

Regulators are scrutinizing neobanks' card offerings.

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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 file to score or no file at all. That puts them in a credit trap: To build credit, these consumers need someone to give them a line of credit with which they can demonstrate good financial habits. But with scores that low, few lenders are prepared to offer them anything.

Neobanks say they can solve the problem through a new twist on secured credit cards. But regulators are already scrutinizing their offerings.

Secured credit cards have been an answer to the thin-credit problem for decades because they allow subprime borrowers to open a line of credit when they otherwise can’t by depositing cash upfront. That sum determines the borrower’s credit limit, and gives the banks collateral to hold on to in case of default. However, most require several hundred dollars as a deposit and impose hefty interest rates and fees, which low-income borrowers struggle to afford.

Payback time?

Neobanks say they can avoid those problems and still help users build credit through secured credit cards that allow customers to repay their credit balance directly using their deposited cash, rather than keeping that money set aside. The products allow customers to build credit while paying for everyday expenses, neobanks say, without having to save up extra cash first.

Chime, Varo, and GO2bank describe it as a win-win for consumers and fintechs — consumers can raise their credit scores, and the neobanks earn loyal customers.

But some in the industry see red flags. “They are, functionally, prepaid credit cards,” fintech analyst Alex Johnson told Protocol. That raises the concern that neobanks may be helping users increase their credit score with a tool that doesn't actually indicate their ability to repay. “If I was a lender, I’d be pissed about having to untangle the trade lines in these consumers’ credit files in order to make sure I wasn’t mistakenly granting credit to high-risk applicants.”

Chime, Varo, and GO2bank’s secured credit cards each have similar mechanics: First, a user moves money from a checking account into a separate credit-builder account. The amount of money they move determines their credit limit: If a user moves $200 into the credit-builder 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 balances with the money they’ve deposited — in this example, that same $200. Both Varo and Chime also allow users to sign up for automatic payments.

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

With this distinction, neobanks are subject to regulations that govern credit but not debit cards, like the Truth in Lending Act. They also, crucially, can market the cards as credit-building tools. The companies make 1% to 2% more in interchange on credit cards than they do on debit cards, though pending legislation may curb these fees.

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

Varo and Go2Bank both say they are not worried about pending legislation changing the amount they can charge on interchange because the credit-building products are not a core source of profit. Rather, representatives of both banks told Protocol the product serves to help them meet customer needs and thus build goodwill with their users. “We’re building deeper connections and deeper engagement,” Raktim Mitra, Varo’s head of credit cards, told Protocol.

The CFPB acknowledged Varo and Chime’s secured credit-builder products in its 2021 Consumer Credit Card Market Report, without mentioning whether the products might deserve further scrutiny. When Protocol asked the bureau for an update on its views, a spokesperson said that “the CFPB is aware of this market development, and we are monitoring this issue closely.”

A spot of ambiguity

For consumer advocates, the ambiguity around such programs is a symptom of a larger problem: The CFPB has yet to bring neobanks fully under its regulatory purview. Under the law that created it, the bureau can supervise financial institutions with over $10 billion in assets and certain participants in consumer financial markets, like those that work in consumer reporting, debt collection, or the servicing of some loans.

The bureau invoked a dormant authority to investigate nonbank fintechs in April of this year, though consumer advocates have been advocating for more regular and thorough supervision. “There’s no accountability as of right now,” said Rachel Gittleman, head of financial services outreach at the Consumer Federation of America.

Gittleman’s primary concern with the credit-builders is that consumers may not understand they are using a lending product, despite the terms and conditions laid out in fine print. Though Chime, Varo, and GO2bank each market their products explicitly as secured credit cards, they downplay possible negative impacts on a customer’s credit, and automatic payment options make the products feel more like a regular debit card that doesn’t have default risk. Neobanks, Gittleman warns, have a habit of “marketing the way [they] want the product to be viewed rather than what the product is.”

Representatives from Varo and GO2bank disagreed. Varo’s Mitra pointed out that customers must have a qualifying deposit of $500 to use the product, which he said helps customers understand that they are signing up for a credit product rather than something entirely risk-free.

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

“Access should not be a privilege,” Chaudhary said, quoting a common refrain of Green Dot’s CEO Dan Henry. “Credit-building is a journey, and a big enterprise initiative for us — secured credit cards are just one part. We are continuing to invest.”

Correction: This story was updated on Oct. 5, 2022, to list Varo's qualifying deposit amount as $500.


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