Fintech startups are increasingly leaning into lending for more than a third of Americans with subprime credit scores. Their vision is to turn a negative connotation into one that not only helps short-term borrowers, but builds their credit and provides financial education.
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The term “subprime” is usually applied to a borrower with less than perfect credit and a FICO score below 670, a category that 34.8% of Americans fall in, according to the credit bureau Experian. (FICO is short for Just Isaac Corp.the first company to offer a credit risk model with a score.)
People in this category typically have few borrowing options other than a subprime lender, which can lead to a cycle of debt, according to Josh Sanchezco-founder and CEO of the financial application float me.
“The whole problem is that there’s no alternative to payday loans,” Sanchez told Crunchbase News. “Overdraft fees are also a huge problem. Even during the pandemic, banks were charging overdraft fees knowing people were losing their jobs.
In 2019, about 37% of Americans said they didn’t have enough to cover an emergency expense of $400. according to the Federal Reserve.
And when they find themselves in an emergency, there aren’t many places where people can get loan assistance, according to Nathalie Martinprofessor and holder of the Frederick M. Hart Chair in Consumer and Clinical Law at University of New Mexico School of Law.
“Studies have shown that people don’t shop around, mostly because of desperation and the fact that there’s not much difference in the price of payday loans,” Martin said in an interview.
She sees two problems with current loans: loan fees are often high relative to the loan – think $50 fee for a $100 loan – and people are often caught in a “debt trap” where they continue to pay these fees and never reimburse them. the principal of the loan, resulting in the repayment of much more than was originally borrowed.
Borrowers in desperate need of money often don’t look closely at the cost of the loan when looking for a lifeline, she said, only to realize as they pay it back how much it is. really expensive.
Invest in new methods
Since 2017, more than $94 billion has been invested in U.S. companies focused on financial services, according to data from Crunchbase. Between 2019 and 2020, funding increased by 29%, although the number of investments decreased by almost 13%. So far in 2021, $19.5 billion has been invested in the sector.
Over the past six months, venture capitalists have funded a number of startups focused on alternatives to payday loans and financial literacy, including FloatMe, which in December raised a seed of 3.7 million. dollars led by ManchesterHistory.
Other recent U.S. investments in space include:
Latin America has also become a hot market for startup innovation in the consumer lending category. Based in Mexico City gravity earlier this month, raised $2.5 million in a funding round led by active capital to develop a buy-it-now, pay-later concept for millions of low-income, unbanked families in Latin America who find it difficult to purchase home appliances.
Baubap, a mobile lending platform also based in Mexico, closed a $3 million growth round from Mexican financial services firm Grupo Alfin in March for its proprietary technology to boost financial inclusion and education . And last November, Monashees and ONEVC led a $5 million seed round in a Brazilian fintech startup Facewhich is developing a financial education platform that not only offers free lectures and courses, but also payday advance services.
“I’ve seen a lot of people using apps that help you get your money two days earlier, as well as more real-time access to funds to pay bills when they get them,” Lynn told Crunchbase. News. “You don’t wait for a pay cycle, there is cash underwriting made possible by companies like Plaidand it is much cheaper for service users.
Lynn spent 20 years in the credit industry, going through several cycles. She warns other investors that subprime mortgages are a dangerous category to gamble in and that companies should choose companies wisely based on how operations are actually going.
In 2019, Canvas invested in Possibility of financinga Seattle-based company that helps people with little or no credit history access credit and improve their financial future “without being predatory,” Lynn wrote in her blog post.
“Possible did well in COVID, which tested it under pressure,” she added.
Exchange of cash for credit
Sanchez himself had his own brush with payday loans: he was involved in a car accident and didn’t have a credit card, so he took out a payday loan that ended up putting him in financial trouble .
This prompted him and two co-founders to launch Austin-based FloatMe in 2018 to provide interest-free, credit-free “floats” up to $50, account monitoring to avoid overdrafts, and savings and education tools.
If more people like Sanchez, who have experienced the negatives of payday lending firsthand, enter the lending space with transparency and education, it will be good for the industry, Martin said.
“We have a chance to make it work for people,” she added.
Sanchez found that when someone qualified for a $200 advance, even if someone didn’t need the full amount, they often took it, but then found themselves in a $200 hole as the interest and fees increased. Instead, smaller amounts — think $20, $30 or $50 — are easier to repay, he said.
“The solution proves that even a small amount can make a difference,” he added. “That could mean being able to put gas in your car or pay the minimum payment on a credit card or buy food.”
Over the past three years, FloatMe has processed nearly a million of its small “floaters”, which use cash flow underwriting as the basis for loans compared to traditional credit scoring, which is not “size unique,” Sanchez mentioned.
The cash flow method means that the company looks at the borrower’s expenses the day before and the day after someone’s payday and the income that comes in. This method allowed FloatMe to make good decisions and trust a model that can complete the credit. scores, he added.
FloatMe plans to expand beyond helping consumers with their cash flow shortfalls, Sanchez said. The company has a budgeting feature in the works that will be released in late May and is exploring other revenue opportunities for users. It may also offer credit products in the future.
“A person’s biggest expenses are rent and bills, which leaves some capital for the rest of the month,” Sanchez said. “It is difficult to get out of this situation. We need to do better as an economy to unlock earning potential and limit the rising cost of living.
When the president Joe Biden took office in January, one of his stated priorities was to investigate payday loans, suggesting that the Consumer Financial Protection Bureau would like become a “consumer watchdog” under his administration.
America’s credit and loan problems won’t be easy to solve, Lynn said. She has seen different incarnations of the payday loan concept, some of which offer interest-free loans but with subscription fees.
There should continue to be options for consumers who live paycheck to paycheck to manage and improve their finances, coupled with financial literacy education, she said.
“If all credit options were taken away, it wouldn’t allow someone to grow,” Lynn said. “Companies must also provide credit transparently and ethically.”
Payday loan interest rates are regulated at the state level. That means it would be difficult for the federal government to set an interest rate cap, although a federal cap would be one way to solve the problem, Martin said. CFPB has created rules for lenders, including the “2017 rule”, which prohibited lenders from debiting a borrower’s account under certain conditions, and required lenders to determine whether borrowers could repay their loans.
Another would give the CFPB more power to investigate lenders.
“Some of the smaller loans may have higher interest rates and require a higher cap, but there could also be solutions like a waiting period between loans or limitations on the number of loans a person could contract over a period of time,” Martin added. “It’s also time to start thinking about how to regulate new products on offer.”
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Drawing: Dom Guzman
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