How lending startups are trying to edge out payday lenders

Despite transaction fees as high as 15 percent and annualized interest rates as high as 400 percent, a staggering 10 to 12 million Americans take out payday loans each year.

And a new legion of lending startups serving non-prime borrowers like LendUp and Elevate are hoping to cash in on the space traditionally held by payday lenders, a market estimated to be worth $38.5 billion. (Other online lenders like Prosper and SoFi target borrowers with high credit scores.)

“If you take out the fintech lending, what are the options? With traditional banking, it’s basically credit cards,” said George Hodges, director of strategy and fintech innovation at PwC.  Most banks and lenders don’t offer loans below a threshold, usually $3,000.

The selling point for startups: Customer experience and financial inclusion. Fintech companies like LendUp, Elevate and others have jumped in with a promise to lower fees and broaden access to credit.

These online lenders compete directly with payday lenders on customer experience. That’s not hard to do. Traditional payday lenders don’t exactly have the greatest reputations — it’s considered high-risk borrowing that preys on the poorest and often offers a less-than-glamorous in-person experience. Still, they’ve been the de facto way to get small loans quickly — especially for those with weak credit.

Fintech startups operating in the market are also pushing a customer-centric approach, saying they work with the customer on repayment terms instead of resorting to heavy-handed, predatory tactics.

“If a customer is struggling to make payments, we offer flexible terms and programs to help that person get back on track. We have a strict policy on nonaggressive collections practices,” said Elevate CEO Ken Rees. “If in the end, the individual must default on their loan, we write it off as a loss.”  

Another sell that fintech startups offer is to help get customers who are underbanked or have thin credit files into the financial system. While Elevate offers loans between $500 and $3,000, LendUp offers customers options below $500 with opportunities to increase the amounts after showing good repayment history. Both offer installment loans that allow customers to pay back the loans over time and assess ability to pay using a broader range of data than just raw credit scores.

“Along with the application of industry-leading advanced analytics, we are able to ensure that we loan money to the most deserving applicants — those who are most likely to be able and willing to pay loans back,” said Rees.

LendUp doesn’t touch traditional credit scores for many of its products including its short-term loans, relying on alternate data sources including information provided from subprime credit bureaus.  “A hard inquiry on the customer hurts their credit score — for a loan of a month, you don’t want to damage their score, so we’ve chosen not to use FICO or the big three credit bureaus,” said COO Vijesh Iyer.

The other related selling point is to position themselves as inclusive.

If fintech lenders are able to use advanced data analytics technology to underwrite a larger cohort of borrowers, it’s a win for financial inclusion, said Hodges, who acknowledges these loans aren’t a cure-all for poverty. But what happens after the loan is an important difference when compared to payday loans.

“In addition to the APR, it’s what happens at the end of the loan,” he said. “In payday lending, it rolls over [if the customer can’t pay on deadline] — it’s not designed to lift themselves up or build savings.”

By contrast, fintech startups say they help customers gain a foothold in the financial system. LendUp and Elevate say customers that have good payment histories can lower their APRs over time and have the option of getting their payment history reported to credit bureaus.

But this does come at a cost.

Both Elevate and Lendup have annualized interest rates that can go into the triple-digit percentages for new customers. Iyer said APRs depend on the state, but a look at LendUp’s sample fees for California on its website shows annualized interest rates for a new borrower that range from 214 to 459 percent, depending on the amount loaned and the repayment time frame. Meanwhile, according to Rees, Elevate’s average APR is 149 percent (but there is a range, depending on credit, employment and loan repayment history and other factors). In comparison, payday lender Advance America’s APRs for the same state are 456 percent, according to its website.

Despite the high interest rates, these loans are intended for quick payback, so to lenders — whether fintech or payday loan companies — the high interest just amounts to a fee for a service banks aren’t well-positioned to provide.

“We think of what we charge customers as more of a fee than an APR,” said Iyer. “For a 14- to 30-day loan of $250, we’re looking at a 15 percent fee; we view that as comparable and in many cases cheaper than what your bank charges you for an overdraft.” He noted that converting interest rates into APRs doesn’t make sense for a short-term loan.

The FAQ section of Advance America’s website has a similar message: “A typical fee for a payday loan is $15 per $100 borrowed. … Often, the cost of a cash advance may be lower than the alternatives considered by many people, such as paying a bill late or incurring overdraft fees from banks and credit unions.”

To Jamie Fulmer, svp of public affairs at Advance America, the entry of new players on the market is a positive development, but the notion that their products are substantially different from payday loans may be a stretch.

“A lot of these companies that are touting a better alternative are trying to make their product look better than a traditional payday loan, and that’s just marketing spin,” he said.  “Some are not operating under the same regulatory framework we’re operating under, and some are doing exactly what we’re doing but marketing it in a different way.”

Still, the fees for small-dollar loans draw criticism from consumer advocates.

“Whether it’s Elevate or a payday loan operator, it’s primarily the same problem — these loans are high-cost and targeted to individuals who don’t have capital or assets to begin with that are excluded from personal loans or high-credit products,” said Ricardo Quinto, communications director at the Center for Responsible Lending, a nonprofit advocacy group with links to a credit union.

From a venture capitalist perspective, it’s too early to tell if fintech lenders’ business models can be sustained over the long term.

“The bets they’re making is that they’ve got all sorts of data, and put that into an algorithm and make better determinations of whether someone is able to repay a loan,” said Vica Manos, director at Anthemis Group. “We still need to see how it plays out. None of these lending propositions have actually been tested in a crisis situation — they haven’t gone through a downturn to test how robust the algorithms are.”

The 6 shadiest fintech industries

sketchy fintech companies

Read the fawning media and fintech bloggers and you’d think that the fintech fairies can do no wrong — that all these startups and technologies making their way into incumbent financial institutions were sprinkled with special fintech dust that makes the problems and conflicts of that curmudgeon ol’ financial industry just, well, go away.

Now, with the fintech blessing bestowed upon us, we’re just angel-pure ethereal unicorns making everyone, including financial clients, richer. Mo’ money! Of course, that’s not actually the case and just as finance has always had a predatory, ugly side, so, too, does fintech.

In spite of the lofty intentions of some of its participants, fintech doesn’t automatically clean up the financial industry. Proof is in the pudding. Here are 6 shady fintech industries that could use some cleaning up.

Forex / Binary options

These financial companies masquerading as financial firms are bad news. Headquartered in countries like Cyprus and managed out of Israel, these companies are the pox on the home of fintech. These companies play the role of house to their legions of unsuspecting gambling clients. The thing is, they’re dressed up as investment platforms, but they’re playing a totally rigged game.

Forex firms’ clients bet on moves in currency pairs and they do it with a lot of leverage (used to be 200x, now, it’s more like 50x) . Sure, that leverage is great if it works out for you. If it doesn’t, poof (that’s the sound of money disappearing). Many of the forex brokerage firms that power these platforms came out of the online poker industry. Binary options are a new twist on the dopamine hit — gamblers bet that a certain stock or index hits a certain price. If it does, they make money. Good luck trying to cash out though — these companies are notoriously quick to take your money but extremely hard to get your money out of. Like a roach motel for cash.

“It’s gambling and we’re a bookie,” an ex-binary options salesman told the Times of Israel, which did a great expose on the industry.

Marijuana payments

The legal cannabis industry is an interesting one, at least from a fintech perspective. Legal sales of marijuana are expected to top $7 billion in 2016 and to surpass $22 billion by 2020. While many states have OK’d the sale of the herb, it’s still a controlled substance at the federal level. That means proprietors can’t really access the traditional banking industry, relying, instead, on fancy armored cars and bodyguards.

They’re lots of examples of companies trying to break this impasse, but most of them lack any traction and look like someone was high when they were designed. Mostly, it’s a child’s game. But that doesn’t mean fintech firms aren’t trying. There’s even an example of a credit union that sued the Federal Reserve when it wasn’t granted a banking license. There’s currently a bill afloat that would prevent the feds from prosecuting companies that provide financial services to legal cannabis companies, but experts don’t think it will pass.

Jail pay

There’s another sketchy form of fintech, one that makes an estimated $500 million dollars each year for the prison system off the backs of inmates and their families. Correctional facilities don’t have a lot of money to throw around for technology for their indentured guests. Instead, companies like Jpay, which controls payments for an estimated 70% of inmates, build out kiosks and tablets where inmates can video chat, use email and send faxes, and receive digital payments from their friends and families. Prisons don’t have to pay anything — these technology and services firms front the money and build out everything on their dime. Prisons then split fees on services.

Thing is, companies like this charge egregious rates: users pay for everything. This becomes a profit center for the jails. Inmates can pay as much as a 30% fee off a wire. Emails, faxes, minutes for phones — everything is nickled and dimed. Certain states have stepped in to cap these outrageous fees and now the FCC is moving in. However, with the system’s hand in the payments cookie jar, it’s going to be hard to change.

Payday loans

Payday loans are kind of like the ugly duckling of finance: they’re definitely part of the family, but no one really wants to take responsibility for them. That’s not exactly true — the Consumer Finance Protection Bureau (CFPB) has upped its game to protect people who, due to dire circumstances or lack of education, get hammered by financial firms who lend off their pay slips. For a type of loan that results 20% of the time in re-borrowing and default, that’s a welcome move.

A few years ago, there was a lot of discussion around online short-term loans that resulted in APRs of 5000 percent. One sorry sap paid 16 million percent. Wonga, a UK lender, received the brunt of the attention from regulators and authorities and has pulled things back. Its payday-like loans still reach levels of 1500+% representative APR. Because many online consumer loans are short-term, they don’t appear to be as expensive as they really are because the gross dollar amounts aren’t eye-catching.

Thankfully, other newer fintech products are almost the anti-payday loan, though, providing borrowers the tools to build credit and eventually, get themselves out of debt. That’s what Lenny does. Even Financial is a marketplace for personal loans that, while not cheap, are probably going to work out cheaper than credit card debt — and certainly a better deal than paydays. LendUp, which bills itself as a payday alternative, helps its clients build credit through education and appropriate financial products.

Bitcoin and other cryptocurrencies

Sure, read the breathless headlines from mainstream media and you may think that bitcoin was going to “revolutionize” payments. Well, sure, it might (actually, its underlying technology, the blockchain, might actually have a chance). But truth is, for now, for bitcoin and most other cryptocurrencies, the only people really using them  are drug dealers and other purveyors of the nefarious.

With a certain level of anonymity, Bitcoin is well-suited for the drug trade. Silk Road, an international online marketplace of all things illegal that was eventually shuttered, preferred to transact in bitcoins. Read the news every week and you’ll learn about international authorities auctioning off millions of dollars of bitcoin confiscated from felons. Just recently, a college student went online to buy LSD and began trafficking it to his school buddies. His currency of choice? Yep, bitcoin.


Sure, with crowdfunding, you can back the next cool watch, music artist, and manufacturer of niche clothes for your pet iguana. But as the fundraising medium made popular by Kickstarter and Indiegogo becomes more commonplace, so is fraud becoming de rigueur.

There are some cases where a crowdfunding project was just an outright sham, a project owner bilking unsuspecting backers and absconding with large sums of money. But then there’s this gray area of crowdfunding fraud. It’s not outright theft, but backers, those people who advanced money to a project or cause they deemed worthy of their hard-earned funds, are left holding the bag. Or more accurately, they’re left with no bag and no product. These cases of fundraising are typically the result of mismanagement or poor planning to bring a new product to market.

Regardless, it’s against outright theft that AIG just launched its new crowdfunding insurance product, protecting crowdfunding platforms, and the people who transact on them, against snake oil salesmen.

A little 3rd party insurance and a little more transparency can help make the dirty underbelly of fintech a little less dirty.


Photo credit: Abi Skipp via VisualHunt / CC BY