This post was originally produced for Forbes.
We’re all familiar with payday lenders who are providing loans to people who can least afford it at interest rates that shock the greediest of corporate bankers. Can a fintech company that lends at rates up to 200% annual percentage rates ever be considered ethical? In this piece, I’m going to share my conclusion.
To help me make this evaluation, I turned to Morgan Simon, a vocal advocate for using a social justice lens for impact investing. She is the author of Real Impact: The New Economics of Social Change and Managing Director of Candide Group. She framed the question for me:
In general, when we think about fintech, from microfinance in the global south to financial services for working class populations in the US, we think a lot about the question of fairness. It’s common for a social enterprise to focus on providing better rates to a customer compared to what they had access to. But better does not always mean fair. So, we always look at a company and try to assess–is the financing non-extractive, meaning the customer receives more value than the company? Is the operating margin reasonable compared to the consumer value created? Does the product help build assets as opposed to focusing predominately on consumption? Each company and case is different, and hence it’s impossible to say that a certain range of APRs enables fairness. It’s important to take each company case-by-case and try to assess its particular impact.
She framed the question well but didn’t answer it for me.
Lendup is a fintech company based in San Francisco with offices in Richmond, Virginia that provides four tiers of consumer lending, with the stated objective of providing customers with a path to better financial health. At the bottom rung of their credit ladder, they provide loans of about $250 at an APR of 200%. The company, backed by Kleiner Perkins, among other well-regarded venture investors, now has 220 employees, has made 4 million loans totaling more than $1 billion. By their estimate, they’ve saved their customers $130 million. They have also provided 1.6 million free online courses about money management.
For this article, I visited with Sasha Orloff, CEO and Vijesh Iyer, COO, to learn 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 Lendup vision, saying, “We believe there are two types of financial products: chutes and ladders. Ladders help people up; chutes 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.”
That lending at 200% interest rates could be a ladder to greater financial health begs scrutiny.
Orloff, 40, was quick to put Lendup’s practices in greater context. “When you’re thinking about the payday lending industry you’re typically talking about 400 to 1,000% APR annualized rates. You’re paying 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 from which the customer might never escape.
The scale of the problem or opportunity, depending on your view of the situation, is staggering. Orloff points out that 56% of Americans don’t have access to traditional financial services. Payday loans are typically not reported to credit bureaus, which serves customers just fine when they default but is no help when they repay the loans according to the terms, leaving them stuck in financial purgatory.
No reader of this piece would want to borrow at 200% unless it were the best available option. Even then, we’d want to be sure that we wouldn’t be better off not borrowing the money.
Lendup takes the ladder concept seriously. Rather than go to a store-front with the employees working behind bullet-proof glass, customers borrow on their phones. They are encouraged to take financial literacy courses. As they make payments in a timely way, they move up Lendup’s ladder, earning the right to borrow more money at lower interest rates. At the top two tiers of service, the company reports credit results to all three major credit bureaus, potentially helping customers establish a credit score that would give them access to traditional credit products, Orloff explains.
Still, I worried what happens to customers that can’t repay their loans on time. Some payday lenders have been reputed to compound interest and fees monthly or even weekly, allowing an unpaid loan of a few hundred dollars to balloon 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 another fee. For their single payment loan customers, no late fees or interest accrue. Instead, the company works with the clients to ensure that customers are not stuck in a debt trap when they can’t pay.
Orloff says, “At the end of the day, we try to structure our products so that we make money when they pay us back not when they get further into trouble because we’re trying to lend people up.”
The problem has persisted despite the continued economic recovery, in part because so many people have been moving from salaried positions to hourly or even to the gig economy where people are paid only for the brief moments when they are working on a paid task. Uber and Lyft drivers, Upwork freelancers, Task Rabbit contractors and so many others now experience unprecedented volatility in their incomes.
Understanding how their model is designed to work, I set out to understand whether or not it does work. Orloff and Iyer were unwilling to provide data on the proportion of their customers who are able to climb to the top of their ladder and graduate. One can reasonably conclude the data isn’t encouraging.
They did share that a comparison of cohorts of their customers and non-customers showed that their customers improved their credit scores faster and farther than non-customers.
Credit scores matter. Iyer notes that a graduate of their program can save hundreds of thousands of dollars over a lifetime by earning a higher credit score.
A graduate of their program gains access to traditional credit cards with a grace period that allows them to borrow money for longer than just one payroll cycle at zero cost. Orloff says, “They’re going from paying 400 to 1,000% APR to a zero-dollar borrowing cost. To me, that’s one of the proudest most incredible things that we’ve accomplished here at Lendup.”
They don’t see Lendup as the solution to the problem. Iyer points out, “We’re talking about over 50 percent of the US population not having $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 collaborates with nonprofits to help address the systemic challenges that make being poor so expensive.
Orloff says, “If our system is working really well for 44% of the country and it’s not working really well for 56% of the country then something has to change.”
He adds, “The reason why I’m excited about this interview and other interviews is creating a broader awareness of this movement has started and that we need the support of a lot of different players from the press from the regulators from the financial markets.”
One of the nonprofits with which Lendup collaborates is The Aspen Institute. Joanna Smith Ramani, the associate director for the Institute’s financial security program, helps answer my fundamental question:
One of our goals at the Aspen Financial Security Program is to build and spotlight leadership that is committed to solving the financial challenges of working Americans. Sasha is a real innovator in the financial service and fintech industry around his commitment to solving not just the credit needs of low-wage earners, but also the overall financial health needs of families as well. We have been encouraged by LendUp’s eagerness to directly learn from their consumers, to iterate their products, and to engage in cross-sector discussions, even with critics and advocates, about how to not just make their product better, but also the industry better.
So, is it ethical to lend to people who are struggling financially at an APR of 200%? Yes. When the customer’s interests are put before corporate interests, lending at such high rates is ethical. But I’ll be watching.
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