Unbanked vs. Underbanked: Who they are and how they differ

Not all Americans are able to enjoy the same financial freedoms. One group of adult consumers, referred to as either “unbanked” or “underbanked,” are credit invisible, which means they have no credit history or a “thin” credit file. As a result, they experience difficulty accessing credit or, if they are approved by lenders or creditors, receive unfavorable credit terms. The Federal Reserve reports 63 million American adults (22%) are either unbanked or underbanked.

Many people use the terms “unbanked” and “underbanked” interchangeably, but they are quite different. Here is an overview of these two terms, how they differ, and what having either of these designations means for tens of millions of American adults.

What does it mean to be ‘unbanked’?

As the title implies, unbanked Americans are people who do not make use of any banking services whatsoever. This includes debit cards, along with checking and savings accounts. In the U.S., 6% of the adult population is currently considered to be unbanked. To conduct their financial transactions and gain access to financial products, unbanked consumers rely on check-cashing services, prepaid debit cards, money orders, pawnshop loans, and payday and other short-term loans.

According to a recent CNBC report, the most common reason people are unbanked is that they do not have enough money to meet minimum balance requirements to qualify for fee-free banking. Other top reasons include a distrust of banks, privacy reasons, high bank fees, and unpredictable bank fees, to name a few. 

What does it mean to be ‘underbanked’?

Underbanked adults make up about 16% of the U.S. adult population. These Americans have some sort of bank accounts, such as checking or savings, but rarely have both. Like unbanked individuals, those who are underbanked also heavily rely on alternative types of financial services, such as money orders or rent-to-own services, to get by in their daily financial transactions. Households are usually given the underbanked distinction if they have used alternative financing options during the previous year.

A deep financial divide amongst Americans

While people at any income level can be either unbanked or underbanked, most individuals receiving one of these designated titles are in lower-income brackets. The U.S. economy operates on the assumption consumers have full access to traditional banking. Unfortunately, the system fails to recognize many individuals, such as the unbanked and underbanked, are routinely denied financial services and access to credit due to this assumption. This results in financial exclusion for millions of people.

The U.S. Consumer Financial Protection Bureau reported on its study in 2016 which found one in 10 adults (this number has slightly decreased by 2019) did not have a credit history with any of the three nationwide credit reporting companies. The federal agency’s report also found consumers in racial or ethnic minority groups, along with consumers in low-income neighborhoods were more likely “to have no credit history or not enough credit history to produce a credit score.” Since that time, the FDIC notes these rates have declined but acknowledges there is still a large disparity in U.S. society.

The COVID-19 pandemic has also deepened the financial divide because of the economic uncertainty that has accompanied it. While the official numbers are unknown as of yet, it is speculated millions of Americans may possibly experience difficulty accessing credit in the future.

Importance of a credit score

Possessing a credit history, along with a credit score, is crucial in today’s society. People who remain credit invisible have difficultly achieving goals that are directly tied to the financial aspects of their lives because the digital divide that existed pre-pandemic and that will continue to exist post-pandemic will:

  • Prevent individuals from accessing financial options
  • Experience a negative impact on their lifestyles
  • Be unable to access options to enable them to build wealth

Alternative services, such as payday loans, money orders, and check cashing, are helpful when there are no other options, but these services can be expensive and, in the case of payday loans with high-interest rates, can result in snowballed debt. Individuals caught in this cycle find it difficult to gain financial freedom because they are always trying to “catch up.”

Alternative credit scores can bring financial inclusion

Fortunately, there is a solution for unbanked and underbanked individuals which can be found in alternative credit scores. This method of scoring can help consumers to gain a favorable credit score and receive financial inclusion. To obtain an alternative credit score, all consumers have to do is sign up for a service, such as Connect, link their accounts, and continue to pay their monthly bills, such as utilities, cell phone, and internet. All credit data is updated in real-time.

Will lenders accept alternative credit data?

Under the Equal Credit Opportunity Act (ECOA), lenders have to take nontraditional credit history into consideration during their decisioning process, provided consumers present the lender with proof that demonstrates a nontraditional payment history. Under U.S. law, businesses cannot legally deny noncredit scoring reports.

Many consumers are finding their nontraditional credit scores are becoming very beneficial. In fact, financial services companies are increasingly marketing to the credit invisible because alternative credit data serves as a reliable indicator of payment history for borrowers seeking loan products.

Contact Connect today to learn how you can receive an alternative credit score

Connect, formerly known as PRBC, has been serving consumers who do not have a traditional credit score since 2005. Through our alternative scoring solution, we are able to help individuals who are unbanked or underbanked be approved by a lender. Through making routine payments on time, consumers demonstrate to lenders and creditors their ability to make responsible payments. As a result, they can be approved and gain access to many of the financial services they were previously denied.

To learn more about how Connect can help you, contact us today.

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