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: Banks are offering credit cards to people without credit scores — will this really help consumers?

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A pilot program is set to launch this year that will offer Americans who typically struggle to gain access to credit the chance to open credit cards. Whether Americans should get one of these cards isn’t clear-cut.

A group of major banks — including JPMorgan Chase
JPM,
-1.41%
,
Wells Fargo
WFC,
-2.17%

and U.S. Bancorp
USB,
-2.19%

— are planning to begin offering credit cards to people who don’t have credit scores, The Wall Street Journal reported Thursday. In lieu of a credit check, the banks will begin to share information from people’s bank accounts among each other and use that data to determine whether they qualify.

(Wells Fargo in a statement said it was “unable to confirm the details or comment” on the Journal’s report, but added that it does not “have anything to correct about what was reported.” JPMorgan and U.S. Bancorp did not immediately return a request for comment.)

The pilot reportedly stems from an effort out of the Office of the Comptroller of the Currency — a bureau within the Treasury Department that regulates banks — that began last summer following the nationwide protests after the killing of George Floyd by a Minneapolis police officer. The initiative aims to provide an avenue to building credit for many people who lack a credit score or file.

An estimated 26 million Americans were “credit invisible,” meaning they either had no credit history or an insufficient history to produce a credit score, according to a 2015 report from the Consumer Financial Protection Bureau. Black and Hispanic consumers, as well as people from low-income neighborhoods, were more likely to be credit invisible, the report found.

Comparatively, only 7.1 million households nationwide lack a bank account, according to 2020 data from the Federal Deposit Insurance Corp. That’s the lowest rate since the FDIC began tracking this data in 2009.

“This can help a lot of people who have been shut out of the traditional ways of building credit, but who are paying their bills on time out of their checking accounts,” said Sara Rathner, credit-card expert at personal-finance website NerdWallet.

The program’s success, though, could hinge on how well card holders can manage their accounts — and how the cards compare to options already in the market.

Opening a credit card isn’t foolproof

Creating more avenues to building credit will certainly be useful to people who have struggled to gain a foothold in the financial services industry. But it doesn’t come without risk, experts warned.

“Expanding access to credit is always, always risky,” said Matt Schulz, chief industry analyst at LendingTree. “There will definitely be folks who get in over their heads with all the newfound credit.”

Opening a credit card can be one of the most straight-forward ways to build credit. And if card holders make their payments on time, they can begin to see their credit score increase within a few months, Rathner said.


‘Expanding access to credit is always, always risky.’


— Matt Schulz, chief industry analyst at LendingTree

But for people who are not used to budgeting in the way that having a credit card requires, it can take some getting used to. “Using a credit card doesn’t feel like you’re spending real money, so the bill at the end of the month may surprise you,” Rathner said.

A surprise bill can quickly become unaffordable, given the high interest rates credit cards carry. The average annual percentage rate, or APR, on credit cards was 16.15% as of May 12, according to CreditCards.com, though the rates charged to people with poorer credit scores tend to be higher.

Either way, the APRs on credit cards are significantly higher than other types of loans. The average interest rate for a 30-year fixed-rate mortgage as of May 13 was only 2.94%, according to Freddie Mac
FMCC,
.

So if someone racks up just $1,000 in credit-card debt and only makes the minimum payment each billing cycle, it would take them more than three years to pay off the balance if the card carries a 20% APR. A person in that position would also likely have a high credit-utilization ratio — a measure of how much of their available credit they’ve spent that’s used in the calculation of credit scores. “That alone could drag down your credit score,” said Ted Rossman, senior industry analyst at CreditCards.com.

Better options may already exist

Many companies have waded into the fray to offer credit cards to consumers with poor credit in recent years.

The Petal Visa Card, which received backing from PayPal co-founder Peter Thiel, specializes in lending to people with new or limited credit. The Petal card even comes with rewards, which the company began offering in 2019.

Similarly, the Tomo Credit Card is targeted to young adults, students and immigrants, and does not require a credit score either. The Tomo card also does not charge interest or fees. Tomo uses bank account information to determine an applicant’s credit limit. Card holders are not allowed to carry a balance. Payments are instead automatically deducted from a bank account to cover the balance, and if it is not paid in full the card is frozen.

Other retailers and financial companies have also made splashy debuts with cards aimed at people who are newer to credit, including Amazon
AMZN,
-1.17%
,
Apple
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-1.12%

and Venmo
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-0.47%
.

 “We’re seeing debit cards and buy now, pay later services — such as Affirm and Afterpay — taking market share from credit cards. I think that’s part of why credit card issuers are making an effort to attract new customers, including credit invisibles,” Rossman said.


Companies like Amazon, Apple and Venmo have rolled out credit cards targeted to people who are newer to credit in recent years.

While banks may want to crack this market that other companies are capturing, the timing of the new credit-card pilot program raises questions. Many Americans have managed to pay down their credit-card debt throughout the pandemic, but banks have remained hesitant to extend new loans given the strong potential for financial distress as unemployment remains high.

“Most credit card issuers are still considerably more cautious now than they were pre-COVID,” Rossman said. The banks have yet to release information on how the new credit cards will work, including how high the associated interest rates and fees will be. Consequently, the new cards may not end up being competitive with those already on offer.


‘Secured cards are great for the consumer because they’re easier to get, and the low credit limits mean you’re not going to go too crazy spending.’


— Matt Schulz, chief industry analyst at LendingTree

Plus, consumers can turn to other, potentially less financially risky options that are far from new. Secured credit cards may be a better option. With these credit cards, a consumer puts down a deposit that functionally becomes their credit limit. They can spend up to that amount, and must pay the money back if they want to charge more to their card.

“Secured cards are great for the consumer because they’re easier to get, and the low credit limits mean you’re not going to go too crazy spending,” Schulz said. High credit-utilization ratios are a risk with these cards, because consumers usually make smaller deposits, though. The cards also don’t carry rewards, and can come with fees that may make them less attractive.

But consumers can usually upgrade from a secured card within a year’s time, Rossman said, allowing them to get access to better card programs.

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