Is it ethical to lend to workers at an interest rate of 200%?
We all know of the payday lenders who give loans to the people who can least afford it at interest rates that shock the most avid corporate bankers. Can a FinTech company that lends at rates of up to 200% annual percentage rate be considered ethical? In this article, I will share my conclusion.
To help me make this assessment, I turned to Morgan Simon, a strong advocate for using a social justice lens for impact investing. She is the author of Real impact: the new economy of social change and Chief Executive Officer of Groupe Candide. She asked me the question:
In general, when we think of fintech, from microfinance in the south of the world to financial services for working-class populations in the United States, we think a lot about the issue of fairness. It is common for a social enterprise to focus on offering better rates to a customer than what they had access to. But better doesn’t always mean fair. So, we always look at a business and try to assess: is the funding non-extractive, which means the customer receives more value than the business? Is the operating margin reasonable compared to the consumer value created? Does the product help build assets instead of focusing primarily on consumption? Every business and every case is different, so it’s impossible to say that a certain range of PRAs allows fairness. It is important to take each business on a case-by-case basis and try to assess its particular impact.
She phrased the question well but did not answer it for me.
Ready is a San Francisco-based financial technology company with offices in Richmond, Virginia that offers four levels of consumer loans, with the stated goal of providing clients with the path to better financial health. At the bottom of their credit scale, they give loans of around $ 250 at an APR of 200%. The company, backed by Kleiner Perkins, among other reputable venture capitalists, now has 220 employees, has made 4 million loans totaling more than $ 1 billion. According to their estimate, they saved their customers $ 130 million. They also provided 1.6 million free online money management courses.
For this article, I sat down with Sasha Orloff, CEO and Vijesh Iyer, COO, to find out what they do and how they justify lending at such rates. You can and should watch the entire interview in the video player at the top of the article.
Iyer explained the Ready vision, saying, “We think there are two types of financial products: chutes and ladders. Ladders help people to climb; falls push people down. One of our core values is that every product we offer at LendUp is a ladder, and our success is measured by the long-term financial well-being of our customers.
This loan at 200% interest rates could be a ladder to better financial health worthy of careful consideration.
Orloff, 40, was quick to put Lendup’s practices in a larger context. “When you think of the payday loan industry, you usually talk about annualized rates of 400-1000% APR. You pay the same rate day after day, week after week, month after month, year after year.
Obviously, lending at half the rate or better than the competition is better for the customer, but it could still be a debt trap that the customer might never escape.
The magnitude of the problem or the opportunity, depending on your view of the situation, is staggering. Orloff points out that 56% of Americans do not have access to traditional financial services. Payday loans usually go unreported to the credit bureaus, which serve clients very well in the event of default, but are of no help when they repay loans according to terms, leaving them stuck in purgatory. financial.
No reader of this article would want to borrow 200% unless that is the best option available. Even then, we would like to be sure that we would not do better not to borrow money.
Lendup takes the concept of scale seriously. Rather than going to a storefront with employees working behind bulletproof glass, customers borrow on their phones. They are encouraged to take financial literacy classes. As they make their payments on a timely basis, they move up the ranks of Lendup, earning the right to borrow more money at lower interest rates. At the first two levels of service, the company reports credit scores to the three major credit bureaus, potentially helping customers establish a credit score that would give them access to traditional credit products, Orloff says.
Still, I was worried about what happens to clients who cannot repay their loans on time. Some payday lenders have a reputation for compounding interest and fees on a monthly or even weekly basis, allowing an overdue loan of a few hundred dollars to spiral out of control within a year. Does Lendup take the same approach to its slow paying customers?
No. They assure me that the company never charges any other fees. For their one-off loan clients, no late fees or interest accumulate. Instead, the company works with customers to make sure customers aren’t trapped in debt when they can’t pay.
Orloff says, “At the end of the day, we try to structure our products in such a way that we make money when they pay us back and not when they get worse because we try to loan people.
The problem has persisted despite the continued economic recovery, in part because so many people have moved from salaried positions to hourly jobs or even to the odd-job economy where people are only paid for the brief times they work. a paid task. Uber and Lyft drivers, Upwork freelancers, Task Rabbit entrepreneurs and so many others are now experiencing unprecedented volatility in their earnings.
Understanding how their model is designed to work, I began to understand whether it works or not. Orloff and Iyer were unwilling to provide data on the proportion of their clients capable of climbing the ladder and graduating. One can reasonably conclude that the data are not encouraging.
They shared that a comparison of cohorts of their clients and non-clients showed that their clients improved their credit scores faster and further than non-clients.
Credit scores are important. Iyer notes that a graduate of his program can save hundreds of thousands of dollars over the course of his life by achieving a higher credit score.
A graduate of his program has access to traditional credit cards with a grace period that allows him to borrow money for longer than a single pay cycle at zero cost. Orloff says, “They’re going from 400% to 1,000% APR at zero dollar cost of borrowing. For me, this is one of the most amazing things we have accomplished here at Lendup. “
They don’t see Lendup as the solution to the problem. Iyer points out, “We’re talking about over 50% of the American population who don’t have $ 400 to take care of themselves in an emergency. “
They see Lendup as part of a growing movement to give people better access to the financial services they need. The company works with nonprofits to help address the systemic challenges that make being poor so costly.
Orloff said: “IIf our system is working very well for 44% of the country and it is not working very well for 56% of the country, then something has to change.“
He adds: “The reason I am excited about this interview and other interviews is to create a wider awareness of this movement that has started and that we need the support of many different players in the press from the regulators. financial markets. “
The Aspen Institute is one of the nonprofit organizations with which Lendup collaborates. Joanna Smith Ramani, Associate Director of the Institute’s Financial Security Program, helps me answer my fundamental question:
One of our goals at Aspen’s Financial Security Program is to create and spotlight leadership that is committed to solving the financial challenges of American workers. Sasha is a true innovator in the financial services and financial technology industry through her commitment to solving not only the credit needs of low wages, but also the overall financial health needs of families. We have been encouraged by LendUp’s eagerness to learn directly from their consumers, to reiterate their products, and to engage in cross-sector discussions, even with critics and advocates, on how not only to improve their product, but also industry.
So, is it ethical to lend to people in financial difficulty at an APR of 200%? Yes. When the interests of the client take precedence over the interests of the business, lending at such high rates is ethical. But I’ll watch.