Fintech lenders that serve subprime customers often weather criticism from regulators and consumer advocates for charging high interest rates or fees that, if converted to an annualized APR, exceed state interest-rate caps.
But there's another view that says some of these fintechs give people who have a low or nonexistent FICO score a way to get cash quickly that is less usurious than alternatives like storefront check cashers, payday loans and flex loans. Then they can put new tires on their car and continue to drive to work, handle a dental emergency, fix a broken refrigerator or meet some other crisis.
A debate has long raged over where such consumers can find fairly priced credit. Regulators and some consumer advocates say the many fintechs in this space that offer quick loans — earned wage access, fee-based peer-to-peer loans or small-dollar short-term loans, for example — charge too much. Fintechs say it's subprime credit cards, payday lenders and "flex lenders" that are predatory. Who is really giving down-and-out consumers a fair deal? Is anyone?
The case against fintech lenders
At the Poverty Law Conference in September, Consumer Financial Protection Bureau General Counsel Seth Frotman expressed the agency's overall distrust of fintech.
"We hear a lot about 'innovation' and 'financial technology' in the consumer financial marketplace," Frotman said. "I'll be totally frank, from what I have seen, there is reason to be skeptical about whether many of these supposedly novel products and services are doing much that is really new or to the benefit of consumers." These fintechs often put a "shiny veneer on top of an age-old practice," he said. Among the fintechs Frotman cited were those providing buy now/pay later and earned wage access loans.
In November, the attorney general for the District of Columbia filed a lawsuit against EarnIn, an app-based lender, for providing high-interest loans to consumers.
Among other things, the Washington, D.C. attorney general said the average interest rate on an EarnIn instant "cash out" is over 300% — more than 12 times the district's 24% interest rate cap. "EarnIn lures in hard-working, cash-strapped workers with the false promise of free instant cash advances, and then charges them unlawfully high interest," the attorney general said. EarnIn charges "Lightning Speed" fees of $3.99 or $5.99 for instant access to funds, he said, and buries these fees in the fine print.
EarnIn responded that workers who use its product can access their earned money for free if they can wait for a few days.
Lauren Saunders of the National Consumer Law Center noted that there's no easy answer to not having enough money.
"Creating a hole in your next paycheck isn't the answer to not enough money," she said. "High cost predatory lending is not the answer to not enough money."
The case for online options
But fintech leaders and some traditional bankers believe there's a place for fintechs that charge fees and rates that exceed 36% but less than check cashers and flex loan providers.
"I think there needs to be options," said Spike Bosch, executive director of BetterFi, a community development financial institution in Coalmont, Tennessee, a town of 1,100 people in Grundy County, in the foothills of Appalachia.
"The financial landscape is lacking pathways to become bankable and to be able to access conventional finance at fair prices," Bosch said in an interview. "That's why things like payday lenders exist, because people need cash. We need fair alternatives that are priced sustainably."
Fintechs and CDFIs give people access to some form of credit or credit builder to build their credit history so they can demonstrate that they are creditworthy so that a bank or credit card company will take them on.
"There's a huge gap in terms of financial services for the underbanked or people with thin credit files or bad credit," Bosch said.
The most predatory loans are flex credit lines, in Bosch's view. Providers of flex credit lines include World Finance, 3D Financial, Advance America, Cash It In, Advance Financial, Check Into Cash, Speedy Cash and Covington Credit. Some of these companies offer payday loans as well.
Though payday loans tend to have the highest APRs, they're typically small, he said.
Flex credit lines let people borrow up to $4,000 and charge almost 280%.
"No one's ever getting out of that," Bosch said. "You can make minimum payments forever and not pay it off." These loans are typically not reported to credit bureaus, and loans that default tend to go to collections lined up with garnishment.
"So it seems like there's been almost an express lane set up to garnish wages," Bosch said.
Where is the line between predatory and affordable credit?
To Bosch, what constitutes predatory versus fairly priced loans is a difficult question. BetterFi charges 24% to 28% interest rates.
"We defend our rate all the time," Bosch said. "Twenty-four percent is not cheap, 28% is not cheap."
The relatively high rate is due to the CDFI's high cost of capital, which it gets from banks at 4% to 8%, and charge-off rates of 15% to 20%. BetterFi charges a $5 late fee if someone doesn't make payments on time.
For some people, a 36% interest rate cap is the bright line between predatory and fair. Forty-four states cap interest rates for loans of $500 to $10,000, and 36% is the typical ceiling.
The flip side of that is, a 36% rate cap means lenders can profitably lend to only around 40% of Americans.
"This is one of these places where the theory and the practice differ," said Laura Kornhauser, CEO of Stratyfy, in an interview. "In theory, I'm very much supportive of affordable terms on credit products. In theory, absolutely we should cap interest rates. Usury laws are extraordinarily important to protect the consumer."
But when such laws are rolled out, regulated lenders stop lending to subprime customers, unless they can charge additional fees.
Tennessee allows CDFIs like BetterFi to charge up to 30% APR. But the state law doesn't apply to payday lenders who can charge a 460% APR, title lenders who can charge up to 264% APR or flex lenders that charge effective APRs of nearly 280%, Bosch said.
The right way to measure the affordability of a loan is total cost, said Rodney Williams, CEO of SoLo Funds, in an interview.
Last year, SoLo Funds, a Los Angeles fintech that runs a platform for peer-to-peer lending for 2 million users, sponsored a report on the cost of credit that showed banks' subprime cards end up being more expensive than SoLo's loans, which have an average APR of 17%. (The company facilitates peer to peer lending without interest charges but with optional "tip" fees to individuals who lend money and "donation" fees to SoLo itself to support the platform. The average tip is 10.4%, and the average donation is 6.2%. The average late fee is 0.4%.)
"It's very, very clear that the fintechs are significantly cheaper, not just us," he said. "Most subprime consumers pay credit cards late, and they keep a balance forever," Williams said. About 80% of SoLo Funds' users have credit cards and of those, about 90% are maxed out, he said.
"That means they're going to take on the average five to seven years to pay off their credit card," Williams said. And the cards accrue interest on the principal, the interest, the late fee and all additional fees. Card issuers' late fees, annual fees and cash advance fees are not considered part of APR, he said.
The important thing is transparency, according to Colin Walsh, CEO and founder of Varo, a fintech that started as a challenger bank and obtained a national bank charter from the Office of the Comptroller of the Currency.
"The APR calculation is really difficult with small dollar lending and we've had this conversation with members of the House Finance Committee," Walsh said in an interview. "The better way to do it is to look at what the alternatives are for the consumer and make sure that when we think about pricing, we want to make sure that we're fair, transparent and probably one of the lowest cost providers."
Kornhauser also believes the important thing is that the borrower knows what they're going to pay over the life of any credit product.
"Where I end up landing on this is the importance of transparency and the importance of competition," Kornhauser said. Stratyfy's software helps lenders analyze credit profiles that are traditionally viewed as risky, and get a truer understanding of creditworthiness.
"Most lenders are still evaluating risk in a way that is antiquated and in a way that doesn't really truly measure the risk of the borrower," Kornhauser said. "So I think a lot of those calculations of unprofitability are wrong or do not leverage advancements in technology."
The true cost of credit is not just the cost of getting the credit, it's also the cost of what happens to your life and your financial well-being after you've gotten that credit, Kornhauser pointed out. Missed payments lead to a lower score, which leads to less access to credit and a higher cost to the credit you do get.
"If then you can't repay it because of onerous fees or a fee structure you didn't understand or you fell on hard times and you get another mark on your history and your credit report that then sends your credit score lower, which then means you have even less access to affordable credit, which then means now all of a sudden, you're working just to pay off the fees and interest rate as opposed to lessening the principal," Kornhauser said. "And now this debt is just like the albatross on your back that you can't get off. The psychological impacts are massive."
