An invisible market of 70 million

Almost 30% of Americans don't have a credit score, but many are actually quite creditworthy. Learn how alternative financial data can unlock this hidden market.

Jason Gross is the co-founder & CEO of Petal. He has spoken on topics ranging from financial inclusion and credit access to AI and machine learning in financial services. Previously, he practiced law at Sullivan & Cromwell and Gunderson Dettmer.

According to the Consumer Financial Protection Bureau, 45 million American adults don’t have a credit score.

That's because they don’t have any credit accounts on file with the nation’s three major credit reporting agencies. Tens of millions more are “thin-file,” meaning they have few (if any) credit accounts listed on their credit report. As a result, they too lack a reliable credit score.

The total underserved market comes out to about 70 million Americans—almost 30% of all adults. This group is disproportionately made up of young people, first- and second-generation immigrants, minorities, and lower-income individuals. (article continues below)

diagram Courtesy of Jason Gross

Because credit scores have become so important in our day-to-day lives, these consumers can face serious challenges. Most landlords today run credit checks before renting to a prospective tenant. More and more employers are viewing candidates’ credit histories as part of the hiring process. And financial institutions are reluctant to provide credit cards—or even used-car loans—to the credit-invisible, except at the highest interest rates.

Unfortunately, the path towards credit “visibility” is not exactly straightforward. It’s hard to qualify for credit if you haven’t had credit in the past, and the kinds of credit products that are available to consumers without a credit history are often limited and expensive.

Invisibility does not equal risk.

The irony is that many of those shut out of America’s consumer credit system may not be poor credit risks at all.

In 2018, 50 percent of college students who entered the workforce were making more than $50,000. Immigrants, too, work in lucrative jobs at disproportionately high numbers: 32% of all computer programmers are U.S. immigrants, as well as 30% of healthcare support professionals and 26% of physicians.

More than 70 million Americans don’t have a safe, modern, and affordable way to access credit. It doesn’t have to be that way.

Case in point: In 2005, a young Turkish immigrant began his undergraduate studies in engineering at the University of California, Berkeley. Without a credit history or local connections, he had trouble obtaining a credit card, renting an apartment, or even signing up for a cell phone plan. The American credit system had written him off as ‘too risky.’

He graduated from UC Berkeley and went on to receive a Ph.D. in Computer Science from the Massachusetts Institute of Technology. There, his personal experience with credit invisibility motivated him to develop better analytics and algorithmic decision-making. He’s now an advisor to Petal, a firm I co-founded in 2016.

This isn’t just an economic problem; it has societal implications as well. Americans with low incomes have the hardest time finding entry into our current financial system, and many never succeed at all. Equally concerning, people of color constitute a disproportionately large share of the credit-invisible.

Access to mainstream credit services is a critical building block of stability and social mobility. Consumers without it are forced to use other methods to access their money, which often means being overcharged for even the most basic services. Think payday loans and money orders.

That undercuts economic opportunity in America. Shutting low-income individuals out not only robs them of their opportunity to succeed; it also robs the rest of us of the social and economic benefit they might have contributed.

The problem with credit scores.

Technology is changing the way America does business, but the financial industry remains rooted in a credit scoring system developed decades ago.

While there’s a much greater variety and volume of financial data available today, the industry continues to rely almost exclusively on traditional credit scores derived from consumer credit reports. In fact, FICO contends that 90% of top lenders use FICO scores in their lending decisions.

The FTC has found that 1 in 5 credit reports contains a material error.

But there are some major blind spots inherent in this system. First, the millions of Americans with no credit report are essentially shut out from the word “go.” Second, even when credit reports are available, they are often inaccurate. (In a widely publicized study, the FTC has found that 1 in 5 credit reports contains a material error.)

Third, even when there is a credit report and it’s accurate, it often won’t paint the full picture of a consumer’s financial life or creditworthiness. That’s because there is only so much to be gleaned from a record of debt and repayment. Ask any financial coach: they’ll tell you that debt is just one aspect of the overall picture. Without data describing income, expenses, and savings, it’s impossible to evaluate a consumer’s financial position with any confidence.

Every day, so-called credit-invisible consumers deposit paychecks, contribute to savings accounts, and participate in millions of financial transactions that never show up on credit reports. Maybe it’s time to start looking beyond the credit report.

A better way to judge risk.

At Petal, along with our partners at WebBank, we use a technology called Cashflow Underwriting to help assess creditworthiness. We analyze a person’s larger financial record—including how much they make, save, and spend over time, as well as the bills they pay each month.

That enables WebBank to approve more people, increase their credit limits, and lower the cost of credit for Petal card customers. And WebBank, in partnership with Petal, is not alone in using alternative data to achieve better outcomes. Innovators like OnDeck, Kabbage, and Square Capital apply the same principles to small-business lending.

Immigrants work in lucrative jobs at disproportionately high numbers. 32% of all US computer programmers are immigrants, as well as 30% of healthcare support professionals and 26% of physicians.

The data we use has proven itself to be beneficial on both ends of the borrowing relationship. It helps WebBank make more accurate decisions, and it helps the credit-invisible borrower get one step closer to financial wellbeing. Over time, it has the potential to offer many more people a safe on-ramp to credit access.

But to capture and leverage millions of additional data points requires AI and machine learning—capabilities not easily incorporated into the legacy systems run by traditional financial services firms.

A seismic industry shift.

The preferences of the financial services consumer are changing. That is due, in part, to the high expectations of a digitally proficient customer base and the values of a new generation.

Traditional financial services products were developed in the age of “buyer beware” and come with multiple pages of fine print to prove it. Modern technology brings more transparency, more choice, and higher expectations for customer-centric products.

Today’s customer expects honesty, simplicity and transparency. They expect their service providers to be straightforward and to act with their best interests at heart. They won’t stand for less.

Case in point: a recent Deloitte report showed that a majority of millennials would switch financial institutions in favor of a better tech platform. Further, over time, a majority of all customers would abandon a financial institution if its digital channels were not set up to let customers seamlessly make transactions online and by mobile.

Today’s customer expects honesty, simplicity and transparency. They expect their service providers to be straightforward and to act with their best interests at heart.

At Petal, we witnessed firsthand consumers’ overwhelming response to simple, transparent, customer-first digital products when tens of thousands of people signed on to the wait list for the Petal card.

Despite these early advances, we’re only just beginning to establish what a modern, transparent, inclusive financial system might like look like. Working together, traditional institutions and fintechs can build a profitable system that works for everyone—especially the credit-invisible consumer.

Jason Gross is the co-founder & CEO of Petal. He has spoken on topics ranging from financial inclusion and credit access to AI and machine learning in financial services. Previously, he practiced law at Sullivan & Cromwell and Gunderson Dettmer.

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