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Is Loaning Money at a 350% APR Evil?

posted by Bob Lawless

In the early part of this year, a new start-up called ZestCash launched. Founded by former Google CIO, Douglas Merrill, it appears to be an attempt at short-term consumer lending with a Google-like "don't be evil" approach and markets itself as an alternative to payday loans.The venture caught my eye when mentioned in the New York Times this weekend as part of a story about Gil Ebaz's work of adding value to different services by providing better, more reliable data.

ZestCash intends to use different information and algorithms to assess the likelihood of repayment. The New York Times story suggests that this information will include cell phone bills. As someone who works a lot with data, I have little doubt that there is a lot of information that will do a better job of predicting repayment than the information currently in credit reports. Better accuracy should translate into lower interest rates for consumers. If there is transmission of consumer information from an unrelated company to another, as a lawyer I wonder whether this can all be done without becoming a credit reporting agency and triggering regulation under the Fair Credit Reporting Act. But, I presume (or at least hope) ZestCash has lawyers advising it on those FCRA isssues.

Here is the catch, ZestCash's own web site discloses that its maximum rates may have up to a 350% APR. There has been laudatory and not-so-laudatory coverage of ZestCash. As a friend of mine was fond of saying, personally I feel strongly both ways. Demand for short-term consumer loans is not going to go way. High-priced and abusive consumer lending needs solutions, and we should not discourage market-based experiments to provide better short-term loans. ZestCash does eliminate the abusive rollover feature of payday loans. Also, its bounced-check fee of $10 also strikes me as reasonable. ZestCash's web site even directs potential customers to legitimate web sites that help people deal with debt such as the Consumer Federation of America or the Center for Financial Services Innovation.

But, 350% APR . . . wow. Credit unions are offering products similar to payday loans at interest rates under 36%. To be fair to ZestCash, the 350% APR is the maximum rate. It would be useful to know at what actual rates ZestCash's lending is occurring, but the disclosures on its web site suggest rates much higher than what many credit unions offers for a similar product. ZestCash claims to have better predictive models on repayment, but such a high APR would still be suggestive of high default rates. Maybe it is fixed costs that just translate into a high APR, but even considering the fixed costs of a short-term loan, amortizing them over a two- to six-month should not yield such APRs approaching 350%.We need solutions to high-priced consumer lending, but those solutions are not more high-priced consumer lending.


"Better accuracy should translate into lower interest rates for consumers."

Would better accuracy result in lower rates for everyone?

Wouldn't it result in HIGHER rates for those who the model determines are most at risk of default? Or would those would-be borrowers simply be denied a loan?

I was unaware that credit unions offer products similar to payday loans. Can you give me an example, or point me to a source? I'd be very curious.

In my view, APR calculations are a major red herring in the case of short term credit. They escalate exponentially as you shorten the term of the loan, so even a small fixed cost can push the rate to astronomical levels. If what payday lenders or ZestCash do is truly predatory, they should be making money hand over fist. Are they? I'm not sure that they are, which suggests that rates that high are needed to even be profitable. Perhaps the credit unions with 36% rates are just servicing a very different clientele than ZestCash?

ZestCash's high rates reflect high customer acquisition costs. In limiting its market to a handful of states (due to state law restrictions), ZestCash forgoes the opportunity to engage in the sort of scalable brand advertising that can lower marginal customer acquisition costs. As a result, it stuck paying the same click-fees as other online payday lenders. A bank with rate exportation authority should be able to do the same business for much less, if its regulators let it.

That said, Penn State Clips is ultimately correct. This is not really a payday alternative. It is simply another instance of quanitative credit analysis cream-skimming the borrower population, leaving the rest worse off. The same type of cream-skimming created payday lending in the first place when, in the 70s and 80s, bureau scores and statistical credit risk models first divided the market into FICO-qualified and non-FICO qualified borrowers.

Fantastic find, Bob. We do have a couple credit unions offering payday loan-type products at 36% here, more as a service than to make money.I too am interested in what percentage of the loans are at 350% and what percentage are at lower rates, and perhaps they'd tell us. Generally, interest rates for on-line loans tend to be about twice as high as store-front loans with 800-1,000% interest being common. A couple of the Native-owned lenders charge rates more like this, effectively half-price. The rate is still obviously very high but I do wonder how high, on average. The worst part about on-line loans is that the lenders often make it impossible to get out of the relationship, by defaulting the automatic payments to be interest-only. See FDIC case. I take it Zest-cash does not do that? Thanks for posting this!

The problem with payday loans and their high interest rates is that there is a very high default rate. And payday loans generally won't pursue the debtor in small claims (although every once in a while it happens, but not often, due to the high costs). Someone who is in the unfortunate position of taking a payday loan isn't very credit worthy by definition.

ZestCash, sweet. Another vulture praying on the carcass of the American middle class. I guess I don't really blame them any more than a real vulture. They are just praying off something that it is already dead or dying. That said though, if we want to get philosophical about it all, vultures (the birds) can't choose to be vultures. Vultures the ZestCash/payday lender? They make a living praying off the misery of others. I can't call that evil per se, but reprehensible for sure. Whether or not it falls into the evil category will depend on how the treat the ones that end up being unable to pay back.

I am starting a title lending business here in Idaho. The company, Ideal lending LLC, pivots off of better accuracy mentioned in this article. Right now all title lenders in Boise charge a fixed APR usually %300.

My business model will charge a MAX of 150% APR and go down from there. loans will be fully amortizing. Things that will cause a lower APR include:
1: Larger loan amount
2: Longer loan term
3: If I can hold a spare key
4: More ability to repay loan(income)
5: History(if any) with previous loans with my company

Another distinguishing factor is all loans will be approved and given by myself. I have a masters in accounting, and have a heavy automotive background having sold hundreds of cars. I know cars and I know money.

I don't believe 350% is evil or reprehensible, it is just necessary based on the current business model. My business model charging a max of 150% is not a perfect solution, but it is a big step in the right direction.

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