Is it possible to make an honest buck while supporting subprime borrowers?
The future looks grim for payday lenders. Comedian John Oliver has had them in his crosshairs since 2014, attracting millions of viewers and stirring up plenty of outrage. President Obama began expressing concerns about their exploitative lending practices last spring. Google announced last month that it would no longer allow payday lenders to advertise. And now federal watchdogs have unveiled new rules that would dismantle a business model that often traps borrowers desperate for cash in cycles of spiraling debt.
“The very economics of the payday lending business model depend on a substantial percentage of borrowers being unable to repay the loan and borrowing again and again at high interest rates,” Richard Cordray, director of the Consumer Financial Protection Bureau (CFPB), told the New York Times.
Payday lenders say the risks associated with serving subprime borrowers justify their practices (20% of payday loans result in re-borrowing and default). But regulators aren’t buying that argument, and an increasing number of financial technology startups are reinventing the lending business with a model that promises to help borrowers and build their credit at the same time.
“I applaud what the CFPB is doing,” says Joe Bayen, cofounder and CEO of a fintech startup called Lenny, which offers young borrowers credit lines up to $1,000 and a chance to improve their credit scores through a partnership with FICO. “We offer increasing balances based on how a user behaves. Everything is aimed at upward mobility and helping people.”
Payday lenders are “preying on this poor, uneducated market,” Bayen says. “What we do is the opposite.”
Indeed, payday lenders rely on short payback timelines and high interest rates, often creating a debt trap for borrowers. A working mom might take out a two-week, $375 loan to pay the rent; when the loan comes due, if she doesn’t have the cash to pay back the $375, plus interest, the sum gets rolled over into a new loan and the fees begin to mount. (The average borrower, Pew Charitable Trusts has found, is a white woman between the ages of 25 and 44.) At a rally last Thursday in Kansas City, Missouri, outside the CFPB hearing to announce the proposed rules, activists pointed to examples of $500 loans ballooning to thousands of dollars in debt.
Fintech founders like Bayen argue that it’s possible to align the interests of lenders and subprime borrowers, and avoid practices that verge on usury. Lenny, which Bayen launched just a few months ago, was today named one of 16 finalists for the Financial Solutions Lab, a program for companies that improve financial health managed by the Center for Financial Services Innovation (CFSI) in partnership with JPMorgan Chase. Other finalists include eCreditHero, a service designed to help consumers resolve credit report errors, and FlexWage, which offers employees access to accrued wages in advance of their paydays.