Access to Banking: What Does Underbanked Mean?

As our contribution to the ongoing discussion America is having around racial inequality, here is another post in our Financial Discrimination, Access, and Equality series. We will continue to share information about how to recognize and help combat financial discrimination, so please come back to read future posts.

If you’re able to deposit your paycheck into a free checking account, get cash from an ATM in your neighborhood without being charged a fee, have access to credit, and have a cushion of savings to weather a financial emergency, then you’re among the approximately 75 percent of Americans with adequate access to financial services. If not, it is possible you are “underbanked” or even “unbanked”, which could create a significant barrier to financial equity and wealth-building.

For a variety of complex reasons, nearly one-half of African American households are underbanked or unbanked, according to a 2020 McKinsey & Company report. Without equitable banking options, people in underbanked communities typically turn to expensive and often exploitative financial services, which can leave them without the resources to save for the future, access credit, and build wealth.

Fixing this problem requires good faith efforts by state and federal lawmakers, lending institutions, and other stakeholders. The disproportionately high number of Black Americans who are financially underserved indicates that underbanking is both a consequence and a cause of racial inequity. We can’t fix generations of financial discrimination overnight, but addressing the problem and discussing ways to overcome these barriers can help underserved communities bridge the gap.

What it means to be underbanked

During a trip to rural Mississippi in February, 2020, Federal Reserve Chairman Jerome Powell explained the importance of accessing equitable financial services: “Access to safe and affordable financial services is vital, especially among families with limited wealth, whether they are looking to invest in education, start a business, or simply manage the ups and downs of life.”

When you’re underbanked or unbanked, you often have limited options and can easily get trapped in a cycle of poverty, debt, and financial disempowerment. If you have very few bank branches in your neighborhood (or none at all), your local options may include the following:

• Check cashing fees. You may have to cash your paycheck at a check-cashing service, where you’ll pay 1-5% of the check’s amount in fees (and as much as 12%), depending on limits imposed by state laws.

• Higher balance requirements. If there is a bank branch in your underbanked neighborhood, they may require much higher balances to avoid penalties than those in adequately banked neighborhoods (resulting in higher average fees).

• Excessive loan fees. If you need a small loan just to get you through the month, your only option might be to rack up high interest debt like a payday loan, many of which are predatory and designed to keep you in debt indefinitely.

These fees, penalties, and high finance charges may come to an average total of $40,000 over the financial lifetime of underbanked individuals, according to McKinsey. This leaves very little left over for an emergency fund, a down payment on a home, or other means of providing security or seeding investments. Underbanking also presents obstacles to accessing student loans and getting a college education.

People who are underbanked often can’t get the traction they need to plan for the future or build wealth, and are sometimes living one paycheck away from financial ruin. The barriers to these vital services involve geography, economics, and the intergenerational legacy of racial discrimination in the United States.

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Why minorities are more likely to be underbanked

Being poor—especially when you’re living in an economically depressed neighborhood—means you’re less likely to have access to equitable financial services, regardless of race. So, what role does race have in underbanking? The answer is complex, rooted in the legacy of racism in general and redlining in particular.

A 1930s government-sponsored program intended to boost white homeownership at the expense of prospective black homeowners resulted in segregated maps outlining minority neighborhoods in red (hence the term “redlining”). Federal loans for homes in the redlined areas and to black borrowers in general were routinely denied. Since homeownership is one of the best ways to build wealth, this practice excluded generations of black and other minority families.

The wealth gap remains starkly divided along racial lines, as the median net worth of white families was $171,000 in 2016, compared to just $17,150 for black families, according to the U.S. Federal Reserve. While the reasons for the racial wealth gap are many, redlining certainly contributed to the disparity, especially when you consider the cumulative effects of home value appreciation and inherited wealth on successive generations.

Source: Brookings Institute

Taken as a whole, the racial wealth gap, the relative segregation of communities along racial lines, distrust of banks by many black consumers, and other factors, help paint the picture of how underbanking can hit minorities particularly hard.

Why certain communities are underbanked

If financial institutions provided more equitable services to African Americans, they could rake in an additional $2 billion in annual revenue, according to the McKinsey study cited above. These institutions could add an additional $60 billion each year from these same customers if wealth building among black Americans was on par with that of white Americans.

The problem is that the legacy of redlining and the stark wealth gap along racial lines means that many minority neighborhoods are not considered strong markets for traditional banking services—regardless of how desperately they’re needed. Lenders and outside observers often balk at the types of factors that all-too-often plague predominantly black neighborhoods, such as high unemployment, low incomes, and limited economic activity in general.

The cold, hard math may indicate that each potential customer is worth less than their counterparts in more-affluent neighborhoods. They may put very little into a savings account and might be considered less stable customers. Banks also anticipate less interest from personal and business loans in these neighborhoods. Predatory lending institutions, paycheck cashing services, and prepaid credit card vendors then see this vacuum as an opportunity.

But that only explains part of it. Aside from the multi-generational effects of institutionalized racism, prejudice among traditional lenders and investors also plays a role. Controlling for all other factors, just the mere perception that black-majority neighborhoods have less value than their white-majority counterparts also may discourages economic development, including banking activity. A 2018 study by the Brookings Institution concluded that 3.2 million owner-occupied homes in black-majority neighborhoods valued at $609 billion would be valued at $765 billion (25.6 percent higher) if not for the impact of that perception.

When you consider all of these factors, it’s easy to get discouraged. But there are things individuals can do to protect their financial interests and make the most out of an unfair set of circumstances.

What to do if you are underbanked

This is a wider, tougher problem than can be handled by any single person. However, if you are struggling due to a lack of access to banking options, you can consider the following:

Look into a more traditional “second chance” account

If you’re underbanked but still have access to a bank or credit union, it may be in your best interest to open a checking account there. Even if you’ve had trouble in the past, many larger banks (including PNC Bank and BBVA Compass) offer “second chance checking” programs with tighter limits on purchases and balances. Once you’ve proven yourself, after a year or so, you may be transitioned into a regular account. These operate a lot like secured credit cards.

Consider online banking

Newer alternatives include online banks, part of the broader “fintech” boom. These companies aren’t as focused as traditional banks are on past financial challenges or other factors that typically serve as barriers for underbanked customers. And since the bank infrastructure is pretty non-existent (no brick-and-mortar bank branches or vaults filled with cash), and often deals in cash-free transactions, they’re often better able to keep costs low for customers.

Or, consider mobile banking

African American app developer Sheena Allen, who grew up in the relatively unbanked small town of Terry, Mississippi, created an app called CapWay* that aims to help unbanked and underbanked individuals. Customers can use the app for online banking without minimum balance requirements, monthly fees, or overdraft charges, and can withdraw cash with the CapWay debit card at MoneyPass ATMs without paying a transaction fee. The app also educates consumers about financial best practices and sends alerts prior to automatic withdrawals (such as online subscriptions).

Improve your credit

The stated mission of another fintech company, Juvo, is to “establish financial identities for the billions of people worldwide who are creditworthy, yet financially excluded.” Essentially, this mobile-based platform enables people to build their credit history through the app, by virtue using it for depositing checks, withdrawing funds, and taking out small loans. Customers are rewarded with access to gradually larger loans (at better terms) as they improve their “Identity Score,” which is similar to a traditional credit score, but derived using Juvo’s proprietary algorithm.

Manage your debt without payday loans

There are an abundance of online options to traditional banking and you should do your research before selecting any one. But if you can’t consider new credit or a savings account because you find yourself in a financial hardship due to an event like illness or job loss, it’s best to avoid payday loans or other options that could cause additional long-term pain.

If you are suffering a financial hardship, and looking to get onto a path of recovery, one option is debt settlement, where you stop paying your creditors and instead put money into a special account. Once you have enough money saved up, a company acting on your behalf negotiates with your creditors for a lower payoff amount. Once a deal is reached and the negotiated balance is paid, the debt is settled. Since you pay less than originally owed, and since you may learn the habit of savings, this option can give you a push toward a fresh start with your finances that is not part of solutions like payday loans.

Other common debt relief options include credit counseling, consolidation loans, and—as a last resort—bankruptcy. Once you have your debt and finances on a better path, you can begin to pursue long term goals like homeownership, college for the kids, or retirement savings.

Don’t let underbanking keep you from reaching your goals

We don’t have all the solutions to the discrimination that affects so many, including those who are underbanked, but Freedom Debt Relief is dedicated to being part of the solution. We will continue to provide information about these challenges to help you understand your finances, rights, and options, so you can better protect yourself and reach your financial goals. Please return to our blog section for additional updates.

*Editor’s Note: None of the companies mentioned in this post are specifically recommended by our writers, nor do we intend to provide banking or financial advice. We aim to bring you information that you might not easily be able to find on your own, and broaden opportunities and the conversation around managing money for all readers.

Learn More

• What You Should Know About Access to Student Loans (Freedom Debt Relief, Link TBA)

• What You Should Know About Credit Discrimination (Freedom Debt Relief)

• 25% of US households are either unbanked or underbanked (CNBC)

• 5 Tips for Creating an Easy Budget if You Hate Math (Freedom Debt Relief)

• Payday Loans (Federal Trade Commission)

• Underbanking in the United States (Georgetown Journal on Poverty Law & Policy)