I bought my first house with my best friend, Steph. Seasoned bartenders, we made a good living. There were two issues for our mortgage lender:
As tipped workers, we only made half the hourly minimum wage per shift. With cash always on hand, we steered clear the trappings of credit cards. This meant two things in securing a loan:
After a 16-year hiatus, I’m picking up bartending shifts again (#founderlife). The biggest difference between then and now is the absence of cash. Nobody pays with cash anymore.
There are not enough cash sales to cover our nightly tips from credit cards. We used to take home all our tips in a single night. Now we take home the cash tips, and the credit card tips are added to our bi-monthly paycheck. Here’s an example of a nightly tip-out.
The obvious downside of less cash today is that I no longer take home all the money when I make it. If it worked this way in the “old days” it would have made proving my income a lot easier. It still fails in two ways:
I’m sure you’ve heard of Affirm, Afterpay, or Klarna by now. These popular “buy now, pay later” (BNPL) services are nothing new. BNPL likely began in the 1980s with department stores and exploded in popularity with the rise in digital purchasing. You would think (or at least I did) that BNPL would help folks build good credit. Not so fast.
BNPL plans are, by nature, short-term loans. As mentioned, you'll commonly pay off a BNPL purchase within three months. But when you pay off a loan and close out that line of credit, it can reduce the average age of your open accounts and potentially drag your credit score down. This is even more likely to happen if you're new to the working world and therefore don't have many long-standing credit accounts in your name.
Why 'Buy Now, Pay Later' Plans Can Hurt Your Credit Score -- Even if You Pay on Time
by Maurie Backman | Published on Nov. 2, 2022
From proving income to building credit, establishing your credibility as one who pays back loans can be a tough hill to climb if you’re an independent worker (#gigworker).
Oh the fateful credit score... it was a rocky relationship when first we met. On steady ground now, I still find it can dip for the slightest of reasons — often not related to my ability to honor financial commitments.
In 18th-century America, credit worthiness was driven by hearsay, rumors, and the opinions of “well regarded neighbors”. It should come as no surprise that rich white men were favored for loans. [1]
In 1989, FICO partners with Equifax, the oldest of three major credit bureaus in the US to standardize on a credit scoring system. It was created to bring a more objective lens to evaluating a person’s credit worthiness.
Not much has changed since 1989, here it is a nutshell [2]:
While building good credit can open a lot of doors, I’m guessing many of us know how quickly it can get out of hand. Jillian Williams of Cowboy Ventures covered the complicated and often confusing relationship our country has with credit card debt. Her findings reminded me of my once rocky relationship with my own credit score. It’s easy to fall back into bad habits when a good credit score earns you so much spending power. It’s practically engineered to be a vicious cycle.
As both generations [Millenials & Gen Z] have aged, it’s clear that neither generation has stayed away from credit cards, and we don’t believe that future ones will either. Credit cards are not inherently bad. They help build credit and may come with more rewards and perks versus debit cards. However, what is concerning is the all-too-easy debt trap due to the lack of financial education and overspending that we have seen across generations.
In 2019, credit card debt hit a high of $926bn, with many lenders expecting pending defaults. 6 months later, however, that debt fell to $811bn, citing the largest 6-month decline ever
However, as we exited the pandemic, these high debt levels have skyrocketed, as credit card debt has reached a new high of $930bn. Q3 saw the largest annual increase in 20 years, with balances rising across age groups and income levels. At the same time, the personal savings rate in the US has plummeted, and the cost of that debt is getting increasingly expensive as interest rates continue to rise.
The Fable and Challenges of Credit Cards in the US, Jillian Williams, December 13, 2022
Here’s the truth. Today’s options for determining credit worthiness are not great for the independent worker (#gigworker). If we borrow a page out of the commercial lending book however, I think you’ll find there’s some very interesting financing food-for-thought.
It starts and ends with cash flow.
Let’s start with a cash flow loan and how it’s different.
A cash flow loan is a type of unsecured borrowing that is used for day-to-day operations of a small business. The loan is used to finance working capital—payments for inventory, payroll, rent, etc.—and is paid back with incoming cash flows of the business.
Cash flow loans are not considered conventional bank loans, which entail a more thorough credit analysis of a business. Instead, a lender makes an assessment of the cash flow generation capacity of the borrower when determining the terms of a cash flow loan.
Cash Flow Loan (Investopedia), By James Chen, Updated July 30, 2021
Since no collateral is being provided, the bank focuses on the quality of your accounts receivable, accounts payable and inventory turnover to see how you are managing your cash flow. Bankers like to see customers who are of good quality and pay as per their terms, suppliers being paid on time (though not too early) and rapidly moving inventory items.
What is a cash flow loan?, BDC
The independent worker has two levers to pull: how much they spend and how much they earn. They look ahead to mitigate issues and capitalize on opportunities for their time. Time is money for them after all. Their cash flow says a great deal about their ability to meet financial commitments.
At the end of the day, determining your credit worthiness is about your ability to meet various financial obligations. In the US, we’ve grown accustomed to our system of credit scoring.
However, our credit scoring system is a pretty arbitrary way to assess borrower risk. Americans only invented credit scores in the late 1980s, and other countries have credit scores that work very differently.
What Countries Have Credit Scores and How Do They Work?, By Nick Gallo, Updated on Oct 6, 2022
🇩🇪 Germany deems you worthy for lending unless you prove otherwise.
Interestingly, the standard SCHUFA score is a percentage that ranges from 0% to 100%. All consumers begin with a perfect credit score of 100%, but it decreases as you pay bills and handle credit. The more responsible you are, the less it goes down. If you can stay above 97.5%, you’re in the top credit tier.
🇳🇱 The Netherlands - no actual “score”.
In general, lenders report to the BKR anytime they issue a consumer credit account for more than $250 with a repayment term longer than a month.
Interestingly, there’s no actual credit score in the Netherlands. Neither the BKR nor any independent companies within the country issue them. Instead of a score, lenders simply review your BKR file to determine your creditworthiness.
🇫🇷 France coming in strong with a model that prioritizes cash flow as proof of credit worthiness.
To top things off, there are no credit scores in France. Being creditworthy generally means having no negative remarks in your history. As a result, lenders can’t differentiate between someone with excellent credit and zero credit history.
Of course, they do have a way to assess a borrower’s creditworthiness beyond checking for historical problems. Generally, when you apply for a credit account in France, you have to submit your bank statements and payslips from the last three months.
Independent workers are on track to the be the new working majority in as little as five years. They take a different view of their money and so should our financial systems.
It’s time we brought a more inclusive lens to a grossly underserved market.
The dominant lending options for gig workers today are predatory at best and downright sinister at worst. Consider the “same day cash” or “get your payday early” promises of sleazy lenders looking to capitalize on the gig-to-gig/paycheck-to-paycheck cycle. Or even that terrible-awful-no-good-very-bad-loan I mentioned with my first mortgage.
We can do better.
Our financial systems were built for and around the traditional salaried worker, because their income is easy to predict.
Steady paycheck = less risky investment.
But the variable income worker predicts their income all the time.
It’s how they build their schedules, manage their day-to-day, and adapt their spending in real-time. The independent worker’s desire to control their work-life balance should be viewed as an opportunity, not treated as a risk. Evidence of an ability to meet financial obligations can be found in their cash flow. So how about we start prioritizing a “Cash Score” when determining credit worthiness?
There are some US companies already catching onto the value of a “Cash Score”. Consider Petal, a credit building app that looks at more than just your credit score.
Petal can look beyond just a credit score and consider responsible spending and saving behavior.
Responsibility to meet your financial commitments is what it’s all about at the end of the day. An independent worker’s cash flow is an indicator of how they deploy their time, or rather — how they run their business. They are, essentially, a business of one.
Let’s afford them the respect they deserve and assume they’re responsible until proven otherwise.
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[1] https://time.com/3961676/history-credit-scores/
[2] https://finmasters.com/when-were-credit-scores-invented/#gref
