A few months ago, I decided to join LendUp, a Silicon Valley-based financial technology company, as its Head of Government Affairs. As a long-time progressive policy strategist, many people were surprised to see me transition to the private sector and to a private lending company.
In 2014, I made a conscious decision to enter the tech sector. My decision was motivated by, among other things, (more on this in later post) a deep desire to solve complex social problems using technology and innovation. My entire life I worked to solve these problems, but never approached them with a market-based solution. This was my opportunity.
LendUp is doing just that: working to solve a complex social problem, payday lending. We are using technology and innovation to create a scalable market-driven solution that brings cheaper, more transparent alternatives to the market. We created the LendUp Ladder, which allows customers to lower their rates over time. And it's working! We have graduated customers who would have otherwise been stuck in payday lending debt traps to sub 36% installment loans and in some cases to a credit card. That is unheard of in the payday industry, but that is the beauty of innovation and technology.
Recently there has been a lot of discussion about fintech, innovation and payday lending. Most recently, Google Banned ads for loan products with an APR above 36% or less than 60 days. As a company working to dismantle payday lending by offering alternative products and providing customers with a bridge to more credit and lower rates, some of our products were impacted. To be honest, my LendUp colleagues and I believe that Google's decision was a step in the right direction. Ultimately we are trying to solve the same problem but from two different approaches, Google from the outside and LendUp from the inside.
Our Co-Founder and CEO, Sasha Orloff recently wrote a great op-ed in Medium that shares the LendUp story, our values, our social impact, and how we are trying to solve the problem of payday lending. I hope that you will read it and comment:
Google is right to ban short-term loan ads, but I won't stop offering short-term loans. Here's why.
by: Sasha Orloff, CEO of LendUp
I think payday loans are deeply problematic. But my company sells short-term loans that look similar and serve the same customers. Last week, Google banned ads for payday loans. Yet earlier this year, Google Ventures (GV) invested in my company, LendUp.
Obviously, this sounds like a lot of contradiction. But the truth is even though we were surprised by the announcement and would have taken a different approach, LendUp and Google agree on a fundamental fact: The current payday loan industry is bad for Americans. Google is applying pressure from the outside, and we applaud them. Meanwhile, LendUp is trying to change the system from the inside, and we have evidence that our technology can create better products for the same customers.
Okay, I know "make the world a better place by selling short-term loans" can sound absurd. If you're skeptical of our intentions -- or just want to better understand exactly how crazy America's credit system is -- please read on.
How I got interested in credit
In 2001, I read a book called Banker to the Poor by Muhammad Yunus. Yunus pioneered the concept of microfinance -- small loans for entrepreneurs who do not qualify for traditional banking. He created the Grameen Bank in Bangladesh, and then an organization called the Grameen Foundation that spread microfinance around the world. Later, he won the Nobel Peace Prize for his work.
Yunus believes that it's possible to eliminate poverty around the world. When I read his book (it's excellent, and I highly recommend it), I decided to get involved. I joined the Grameen Foundation and moved to rural Honduras.
It was supposed to be a six-month volunteer stint, but it ended up being a full-time job for three years as we replicated the Grameen Bank model in other parts of Latin America. While microfinance is not without its flaws, I saw firsthand how well-structured credit helped entrepreneurs start and grow their businesses.
The almighty American credit score
I wanted to see if well-structured credit could similarly change people's lives here in the United States. When I returned, I interned at the World Bank and then worked at Citigroup's Consumer Lending division. One thing quickly became clear: the power of the credit score.
In the U.S., your credit score decides whether you have access to bank credit, insurance, apartments, even jobs. And your credit score dictates how much you'll pay. The average person with a low credit score will spend $250,000 more on interest and fees over the course of their life. That's insane. And we're not talking about some tiny sliver of the population. A full 56% of Americans -- more than half! -- can't get access to traditional banks because their credit score is too low.
Instead, their options are limited to payday loans, title loans, and other dangerous products. This shadow world of lenders has astronomical rates and hidden fees, and doesn't report to the credit bureaus. If your score is below 680 and you don't already have a "respectable" credit line, there are few paths for you to get ahead.
So why don't the banks step up and offer services to this majority of Americans? After the 2008 financial meltdown, "subprime" lending became a dirty word, and banks grew even more hesitant to develop products at the lower end of the credit market. Meanwhile, thanks to the same banking crisis, even more people were now considered subprime.
For people who need to pay a bill right away, payday loans solve a real problem. These borrowers have jobs and make enough to pay the bills, but they don't have any financial slack. When a medical expense or car repair comes up, they can hit a shortfall.
So if the electricity bill is due on the 13th, and payday is on the 15th, what do you do? If you don't have a credit card, you're in trouble. Banks can't or won't help, and in that market -- especially since 2008 -- payday lenders have prospered to fill this growing need.
There needs to be a scalable, self-sustaining solution
I wanted to do something about the credit problem, and I talked over the challenges with my stepbrother, Jake Rosenberg. Jake, who was Zynga's CTO of Platform at the time, saw the situation as especially frustrating because technology had actually made things worse. Payday lenders were using the internet to set up online businesses outside of state-level consumer protection laws. As someone who thinks software should make the world more efficient, not less, Jake found this offensive. Jake believed that better tech could change the dynamics of the industry. Payday lenders always offered the same terrible rates indefinitely. But with better underwriting and more sophisticated technology, borrowers could be offered better rates over time.
So Jake and I decided to found LendUp. The idea was simple: We'd offer loans and credit to people who couldn't qualify for normal banks. We'd charge interest -- in some cases, high interest -- but unlike payday lenders, we'd offer a path to better credit scores, better rates and real banking. We'd also offer financial education, and move customers who took those courses along the path faster. We'd have to build all of our own banking and risk-assessment technology from scratch, but with Jake as CTO, I believed we could do it.
Making positive change as a for-profit company is complex, and we knew that going in. We set up four simple principles, and agreed to follow them to the letter, with absolutely no exception -- even if it hurt our business.
Ladders: LendUp's goal is to provide an actionable path for customers to access more money at a lower cost.
Not chutes: Our business model is based on customers succeeding -- repaying their loans on time and paying off their credit card balances. No rollovers, no debt traps. Ever.
Transparency: We strive to make our products as easy to understand as possible.
Building credit scores matters: While we don't require good credit, our products encourage and reward actions that result in higher credit scores.
Basically, we want our customers to stop needing us for emergencies and give us less short-term business over time -- with the plan to eventually offer credit cards, savings, and investment products as they gain more financial slack.
The LendUp model is already working
What bothers us the most about payday loans is how sticky they are. Even if you pay back a loan, you're stuck: You're always going to be offered the same expensive rate. If you don't pay back the loan, it gets incredibly expensive: fees on top of fees with no end in sight. In states where rollovers are allowed, payday loan rates can climb above 1000% APR.
So we decided to start in the short-term market. We thought we could turn these loans into an access point for traditional financial services. Our first product was an alternative called the LendUp Ladder, and it fixes what's broken about payday loans in a few important ways:
When customers repay their loans, they can be eligible for larger loans at lower rates (it is almost unheard of for payday lenders to offer better terms).
In the top half of our Ladder, customers have the option to have their payments reported to the credit bureaus (payday lenders don't report). When customers need more time to repay, we don't charge them extra (payday lenders use rollovers to make more money when their customers struggle).
When customers make successful repayments, many can become eligible for a credit card (which is essentially an interest-free short-term loan, if paid on time and in full).
As you probably guessed, payday lenders wouldn't dream of offering a credit card to their customers. A credit card, which many take for granted, is essentially a month-long, zero interest loan. It's the surest way to immediately transform the industry -- which is exactly what we want to do.
The early results are encouraging. We estimate we saved our customers more than $16 million in 2015, and we've already saved them another $16 million in 2016. More than 90 percent of our active users have access to credit-building loans within two years. And we've taken customers from having credit scores in the 300s two years ago to having a credit card today.
Yes, we charge high interest rates for first-time customers
First-time borrowers regularly pay more than 250% APR -- which sounds crazy, and it is expensive, but it's risk-adjusted. If you mainly use credit cards, you're probably familiar with APRs between 7% and 36%. But remember, if you have a credit card, you have a track record with the credit bureaus. In order to serve our customers, we take on a lot more uncertainty and risk in the name of helping them take that first step towards elusive credit building. Some customers do not pay us back and, like insurance, the interest rates covers what we lose. But when customers do pay us back, as the vast majority do, they de-risk themselves. Where the Ladder is available, customers move up automatically through repayment, and become eligible for loans at a fraction of former rates.
We saw ourselves as having to make a choice between access and cost, because lowering one means lowering the other. So, first we chose access, focusing on new customers. Then, we built the Ladder to drive down costs for existing customers. Now, as our technology improves, we will continue to make credit more affordable while maintaining accessibility. Today, we regularly approve customers with credit scores in the 300s -- people who banks and credit unions don't serve.
Also, to add context to those APRs, in California (rates vary by state), we charge around 16% (or a fee of $32) to borrow $200 with our short-term loans. The average loan lasts 22 days, so when you annualize our rate, you get a whopping 270% APR.
Our short-term loans are on Google's blacklist, but we're cool with that
So there's the rub. Because we offer short-term loans and charge high interest rates in the beginning, the entry point to the LendUp Ladder will be blocked from paid advertising on Google.
Does it feel good to be lumped in with the industry? Well, not exactly. But the marketing of these products has to change to better protect consumers from deceptive practices, illegal products and identity theft. If effectively enforced, Google's ban will push the payday loan marketing competition away from ads and toward natural search, where safer alternatives with quality content can shine. Obviously, I think that's good for LendUp -- and good for Americans who are locked out of the banking system. We're proud of our work, and we're very happy to take the fight to a more reputable arena.