When most people think of alternative lending, they immediately think of payday loans and other abusive loan products. In the tech world, the first thing that comes to mind are online lenders: those who take loans traditionally originated in person and move them online. That was the first wave of alternative lenders — think LendingClub, Prosper, OnDeck, to name a few.
Since the beginning of 2014, we have seen a new wave of alternative lenders emerge, those who do not move online what already exists in person, but lenders who create completely new products or vastly improve existing products through the use of technology. Bravo Capital, a prime example of this, allows application developers to access their earned cash while waiting for it to be paid out by Apple. Payability does the same for Amazon merchants and Clearbanc is providing short-term financing to Airbnb hosts to unlock future revenues.
Payability, Clearbanc and Bravo represent the future of small business lending. These are businesses that use third-party verified data to make lending decisions. Small businesses practice notoriously poor book keeping, rendering the self-reported financial data unservicable. Lenders are forced to ask business owners for personal guarantees and take unnecessary risks from either asymmetrical information or extremely limited information about a business.
If you are lending to a merchant on Amazon or Airbnb, you can see reviews for their products and services, you can see historical sales, velocity of sales and a variety of other metrics that allow for smarter credit decisions. These data points alone may be better indicators than the business owners FICO for whether or not a lender should expect to be repaid, and in tandem with the FICO score can definitely provide a clearer picture of payback risk. The key aspect here is that the data is verified from a third-party source, thereby significantly reducing the ability of a merchant or host to defraud the lender.
The Gig Economy does not only include small businesses, but also individuals who have jobs that have not previously been underwritten by banks and traditional financial institutions before: Uber drivers, cleaners through services such as Handy or handymen who find work through TaskRabbit. There is verifiable third-party data from all of these sources, yet FICO score remains the preeminent way to figure out whether these borrowers are truly creditworthy.
Similarly, within the consumer finance space a flood of companies are now focused on instant pay based on earned, but as of yet unpaid, days of work. These companies provide significantly improved products to payday loans. Often the fee is just a few dollars, a penny compared to the debt trap of payday loans. The fee is not only much lower, but it is one the lender (or the company that is advancing the wage) knows consumers can repay because it comes directly out of their paycheck. DailyPay, Instant Financial, PayActive, FlexWage, and Earnin are all examples of businesses that are tackling this problem. Walmart has partnered up with the personal finance app Even to offer a similar benefit to its employees called Instapay.
Conceptually, these companies boil down to the reduction of loan payback risk via a change in the ultimate credit counterparty. If a lender were making the same loan to a consumer, with no guarantee of payment coming directly from the company, the fee for borrowing could be over 50 times higher. The next wave of consumer lending is providing consumers credit, while not taking consumer credit risk.
A model of what this can look like can be found in CreditWorks, a company that provides payroll deduction loans. A payroll deduction loan is a financial wellness benefit that can be offered by a company to its employees. An employee who faces an emergency expense can take out an installment loan and reserve a portion of future paychecks to reimburse the lender directly out of the companies payroll. Because the money flows directly back to the lender, the loan can be offered at 5% — 10% of the price of a traditional payday loan. The benefits of this cannot be overlooked.
We are at a point in time in the U.S. where over 50% of our population cannot afford a $400 emergency payment, where payday lending grew three times over from 2001 to 2012, and where the average household carries $15,000 of credit card debt. There there are more payday lending stores than Starbucks and McDonalds combined, even with payday lending being illegal in 14 states. What’s more alarming, 69% of people using payday loans used them not just for an emergency payment, but for a necessary expense. In a country where more than half of our families report struggling financially, and where 60 million of us have no FICO score, innovative financial solutions are direly needed.
No regulation alone can solve these problems, especially with the Consumer Financial Protection Bureau in disarray. We must continue to innovate and create products that provide more Americans access to affordable financing solutions. We cannot wait for Washington DC to protect consumers, we must create products that are affordable to consumer and profitable for businesses. We are on our way, but we have a long road ahead of us…