A buzzy new startup with celebrity investors is trying to steer younger consumers toward debit cards instead of credit cards. While COVID-19 has boosted debit cards, I think building credit and earning rewards is still the better option.
One such example, cred.ai, launched last week with myriad bold proclamations.
“I think cred.ai could one day be viewed as the Tesla of banking,” declared David Adelman, the company’s lead investor and one of its co-founders.
“This is a major swipe at disrupting banking. cred.ai is this generation’s version of an Amex Black Card,” added Tim Armstrong, another of the company’s prominent investors.
His impressive resume includes stints as CEO of AOL and president of Google America. The buzzy startup has also drawn investments from music superstar John Legend and three-time NBA champion Andre Iguodala.
What is credit.ai?
cred.ai is basically a checking account/debit card combo, although it’s technically a credit card. Its most unique feature is that it uses artificial intelligence to optimize credit utilization. That is, it automatically calibrates cardholders’ spending and available credit to improve their credit scores.
It functions like a hybrid secured credit card/charge card, with no preset spending limit but a threshold that dynamically adjusts based upon how much money the account holder has on deposit.
Honestly, it’s confusing, not to mention ironic. cred.ai is preaching about credit utilization to a target audience – mostly Gen Zers and younger millennials – that is new to credit and probably doesn’t know what the heck that means.
Rather than shrouding the process in mystery, I think it’s better to grasp and practice the fundamentals. But you don’t need cred.ai for that (just a starter credit card, like a secured card or a student card, perhaps).
In addition, cred.ai’s messaging is all about traditional credit cards being evil and their rewards being “a karma trap … outweighed by fees and interest.” Yet they’re concerned about helping users build their credit scores. Part of the reason you want to build a strong credit score is to move on to better rewards cards (and savvy cardholders know how to do that without incurring fees and interest).
See related: How to lower your credit card interest rate
Chime recently unveiled a similar hybrid product, the Chime Credit Builder Card. And when it comes to digital-first, low-fee bank accounts that offer debit cards, free ATM access and slick financial management tools, there are almost too many to count.
N26, Revolut, Curve and Simple are all playing in that space, among many others. There’s also a lot of overlap with more established fintechs such as PayPal (which owns Venmo) and Square (which operates Cash App).
This trend started well before COVID-19, but the pandemic is proving to be a tailwind for debit cards. Many consumers are particularly debt-averse these days because of the tremendous uncertainty gripping the economy and the job market. Also, their bank accounts are flush with government stimulus money (everything from the direct stimulus payments to expanded unemployment assistance and the Paycheck Protection Program).
The combined effects have kept debit card spending basically on track (down 3% year-over-year in the second quarter, according to Visa), while credit card spending has plummeted (down 20%).
See related: Coin shortage bodes well for cards
I don’t get it
My advice is to use a credit card like a debit card. That is, pay your bills in full to avoid interest while reaping the benefits of superior rewards programs and consumer protections and building a strong credit score. For your banking needs, it’s easy to find a free checking account from a bank or credit union.
The fintechs that I think could be truly disruptive are the point-of-sale lenders. Some prominent examples include Affirm, Afterpay, Klarna and QuadPay. I think they serve more of an unmet need (affordable financing for people who don’t have ready alternatives). These companies also target young adults and others who may lack credit cards and established credit histories.
They’re not perfect – it’s risky to buy now and pay later for consumer goods like clothes and electronics, and most of these services don’t help you build credit – but I see the appeal for some people.
The debit card craze still mystifies me. When you pay with debit, by definition, you have the funds on hand. Why not use a credit card, pay it off before interest accrues and take advantage of rewards and other perks? The point-of-sale lenders are different because their target audience doesn’t have the money right away, and they probably don’t have a high enough credit score to qualify for better terms.
See related: How to build credit without a credit card
Ultimately, I think all of these alternatives are stepping stones to participating in the traditional banking and credit card establishment. Change comes slowly in the U.S. financial services landscape. Even the most successful tech companies, like Apple and Amazon, are in financial services because they partner with traditional financial institutions such as Goldman Sachs and Chase, respectively.
The U.S. market is heavily regulated and consumer behavior evolves very gradually. The average person should seek to join the system, not attempt to beat it by adopting newfangled alternatives that claim to be the next big thing. Practice good fundamentals that will build your credit score and net worth, and the rest will follow.
Have a question about credit cards? E-mail me at email@example.com and I’d be happy to help.