The secured credit card has long been the industry’s solution for consumers without credit histories. A new generation of credit builder cards is testing whether that solution still holds. Offered by several fintechs, the cards require users to fund an associated demand deposit account—often held at a separate bank—to cover card payments.
A new report, Evolutions in Secured Cards: Not Ready for Traditional Lenders, from Brian Riley, Director of Credit at Javelin Strategy & Research, examines the rise of these credit builder cards and considers what their growth could mean for established issuers and their position in the secured card market.
The Secured Credit Card
The advantages of a traditional secured card program are easy to see. By requiring a deposit account with funds that match the card’s credit limit, issuers can serve young consumers, immigrants, and others without established credit histories. As the relationship matures, the financial institution can reduce the deposit-to-credit-line ratio, with the goal of eventually eliminating the deposit altogether. When done right, this approach can turn a low-credit borrower into a customer for life.
But for much of their existence, secured cards were viewed as somewhat unscrupulous, a province of lower-tier banks. The CARD Act of 2009 put an end to many of the secured-card offers these banks had been promoting.
“You could open the account with a 900 number,” said Riley. “You could get a $500 credit line, with $490 in junk fees on it. There were lots of games on it, but the CARD Act cleaned a lot of that up. That’s when major banks got back into it.”
Competition from the Fintechs
Non-bank fintechs are also interested in building these relationships. However, only entities with bank licenses can take the deposits necessary to support a credit card. As a result, fintechs have developed an alternative model that requires partnerships with established banks: the customer deposits money into a checking account with the bank while receiving a credit card account from the fintech.
Rather than working with major banks, fintechs often partner with regional or specialized institutions like the Bank of Missouri. A few banks either rent their licenses or create white-label programs for fintechs, which typically lack the capital to assume the risk of issuing credit cards themselves.
“Remember if you have just 100 cards out there with a $5,000 credit line, you need close to half a million dollars to support that,” said Riley. “Most fintechs don’t have that warehouse credit access. The banks that have traditional programs can take deposits, hold the funds, and issue on top of all that.”
Assessing the Market
There are no precise figures to measure how widespread the credit builder market has become, but several significant players are active. Chime is now the leader in the category, offering cards through partnerships with Bancorp Bank and Stride Bank. When Chime filed to go public last year, it estimated the market at tens of millions.
“It’s really everybody with a weak FICO score that can’t just go get a regular credit card, which is about 40% of the United States,” said Riley. “Even with that, if you’re just in the prime level, like a 700 score, you can help your credit score by doing a Discover secured card.”
Escaping Regulatory Attention
The newer model offers some appealing advantages. One key benefit of the credit builder card is that it requires less money to leave the household budget when setting up the account. Instead of deposit funds into a traditional secured account, as with the secured model, the money is placed in a demand deposit account, keeping it accessible to the borrower. This flexibility allows credit builder issuers to reach a broader market.
For issuers of secured cards, another advantage is the visibility it provides into cardholders’ payment behavior and their ability to manage household budgets, including how they handle minimum and larger monthly payments.
But a notable concern is that credit builder cards have received little regulatory attention, partly due to the limited oversight capacity of the CFPB. Major banks have not yet entered this space, and fintechs offering these cards are not covered under the CFPB rules. Regulatory scrutiny is likely to increase over time, but the timing and potential impact remain uncertain.
“The cards are going to last for a while until regulators get involved and come back to the way they were, maybe at the next presidential cycle,” Riley said. “This won’t be the first thing on their plate, but sooner or later it will be on there. And banks need to be cautious about it because of the gamification around it. Is it a debit card? A credit card? Why didn’t you use a debit card in the first place?”
Play It Safe
There are no formal guidelines on how these products should work, be priced, or reported. Banks would likely be better off taking a cautious approach by supporting the traditional secured product, which has already navigated the regulatory gamut in 2009.
“Our recommendation is that we don’t think banks should be doing it,” Riley said. “Even fintechs should be wary of doing it. There’s a really good strategic reason to have a secured card strategy, but it’s the one that’s in place now, not the new model.”
Nevertheless, the credit card business can be a copycat industry, with players quick to adopt the latest trends to see if they gain traction.
“What happens a lot in this industry is that somebody gets a new idea, or a repackaged new idea like buy now, pay later, and every bank thinks they have to shift what they’re doing,” Riley said. “But you really don’t want to do it. It’s not really credit that you’re putting out there. You’ve got the money already in the debit account. Just don’t go there because, you know, be a bank.”
