Predatory Debt

Predatory Debt: How Fintech Companies Are Fighting the Beast

What predatory debt can do to a person, is turn them from a lion named Simba, destined to rule the Savanna into a Zebra named Jerry (nothing against the Jerry’s of this world) who’s ever looking over their shoulder for that fateful fall of the hammer.

According to debt help organization, predatory debt occurs in situations where a lender gives people money knowing they can’t afford to pay it back (even counting on it), hides fees, or changes the terms of the loan when a borrower is already committed.

Trap World

For the most part, the goal of predatory debt is to trap people into a cycle of always owing somebody money. Let’s go back to our buddy Jerry, he takes a loan to pay off an emergency medical bill; he got hurt while walking at the park (yeah it happens).

 The terms of the loan have the interest compounding to 400% of the principal amount but Jerry needs the money so he takes it anyway.

He nearly defaults but miraculously the payday lender gives him an option to refinance the loan at a higher interest rate and with additional fees. “Whoa! That was a close one right?” Jerry thinks as he walks back home smiling.

As the debt trap cycle catches momentum, Jerry will stop looking forward to his paycheques as a large chunk of it will now belong to the lender. He will be like the unlucky shop owner in those old mafia movies, having to pay protection money when they can hardly pay their own bills.

Forms of Predatory Lending

This type of lending takes many forms. From a lender giving a home mortgage they know you can’t afford; hoping you default and they foreclose on your house, to a balloon loan with low upfront charges that blow up into large payments later on. Imagine being charged a penalty for paying your loan early. Trust me you do not want to be Jerry.

What is Fintech?

Stripped bare, fintech simply means a combination of financial services and technology done with an aim to simplify a product, increase convenience or in some cases totally re-invent the wheel.

Think PayPal, at its inception, it was completely revolutionary in using the internet to enable payments. With today’s rate of technology growth, that seems almost mundane, but it was revolutionary at the time, and if you look closer you will see the revolution is still ongoing in the financial services sector.

Sector Overview

At the moment the fintech industry is on fire (the good kind). In the US alone, 38 % of personal loans issued in 2018 were through fintech companies.

According to CB Insights data, about 1700 fintech companies managed to convince investors to pump in a total of $39.57 billion in capital in 2018. There are 39 non-public fintech companies whose combined value adds up to $147.37 billion. So clearly the investors believe, but why is that so and what has that got to do with you?

Well, the devil is in the details and the reason these companies are deemed so valuable is because of their potential to completely revolutionize how clients are served. If you tap into this revolution you can find some form of freedom from debt.

Payroll Flexibility

To understand payroll flexibility better, think of babysitting. A baby sitter is paid immediately they finish the job and so is that entrepreneurial kid cutting grass in the neighbourhood.

However, in many traditional structures, work you do on the first week of the month is often paid on the third week (bi-weekly payments). So in terms of payroll flexibility, your baby sitter is better off and better placed to tackle an emergency need for cash.

To cater to this market of inflexible biweekly and monthly earners, payday lenders offer loans that are easy and quick to access without any hassle but at exorbitant rates.  One of the fintech companies I found going after this market is Gusto, a US-based fintech company with a product dubbed Flexible Pay.

How it works is that it gives employees the ability to walk into the bosses office and demand payment whenever they want. Well not exactly, Gusto gives employers the ability to pay employees earlier by advancing them payment so that they are able to pay the employee without affecting their cash flow or at an extra cost to them.

When the usual time for the employer to run payroll comes, Gusto deducts the amount it gave directly without charging employees a service fee. Key to this is that employees are paid only for what they have already worked for, meaning the money they get is not really a loan but an advanced payment. This model takes away the need for employees to go to external sources for emergency financing.

Debt Payoff

The ease with which we can access finance gives debt the stealth to sneak up on a lot of people. If you find yourself sharing a lot of debt inspired memes, you are not alone.

According to the Institute of International Finance, the household debt in the US is a whopping 75 % of the country’s GDP, in the UK its 86 % and slightly over half in the European Union.

Household debt seems to be the norm, ironically though for many people, this is not the main problem, the intricacies of paying them off is.

Keeping track of student loans, mortgage and a host of other payments including interest and payment terms for each of loan you have can be tiring and expensive. Just selecting a wrong payment plan can make your loan much more expensive.

One fintech company tackling this pain point is Scratch. The company automates the payment process by aggregating all the loan information from a customers’ different lenders into one app dashboard.

According to the company, using their app, you can track all your outstanding loans, set a payment date or modify it, see how far off you are from finishing your loan, as well as make plans to reduce the timeline. They also handle customer support issues to take away the experience of having to be put on hold by your lender.

Payday Advance

The startups in this field-in a slightly different way-also provide payroll flexibility by giving salaried workers early access to their money.

One of the interesting ones I found is Earnin, the company helps employees get their money early (at no cost to the employer) and then deduct their advance when the salary eventually comes in. The startup charges zero user fees (yes you read that right) but instead earns from tips that users can choose to (or not to) give.

You can also choose to give bigger tips (pay it forward) to cover someone in the network who may not be able to afford it. Despite its unusual business model, Earnin has raised $125 million in its third round of funding to expand.

One unique feature offered by the company is that for instance, you’ve spent the whole day animating a cat’s ear for an animation company, you can request and receive payment for that day’s work-an ear’s worth.

However, because constant withdrawals can be tempting even to the best of us, the company limits these kinds of withdrawals to $100 per payday period. Users need bank account and employment details to sign up.

Another startup in this field is Salary Finance, who was the subject of a Harvard Kennedy School study that found an increased employee retention rate of 28% for employers that worked with Salary Finance.

 The startup uses employees’ salaries as a basis for advancing loans, consolidating debts as well as enabling employees to get an advance on salaries. The company has recently raised $20 million in its second round of funding and has expanded into the US from its UK home market.

Neyber, also a UK based fintech (the UK has a lot of them) specializes in salary based employee loans. The main motivation for this type of financing is that a lot of loan applications are rejected by traditional banks for reasons not limited to unsatisfactory credit scores.

For instance, according to the Urban Institute’s Housing Finance Policy Center (HFPC) data, mortgage applicants with low credit scores had a 32 % denial rate.

Thus, using the guarantee of Salaries to decide whether to give loans or not, bridges this gap. Apart from loans Neyber also facilitates investing, saving as well as provides online tools for financial education. The main advantage of using tech for all this is that everything is seamlessly integrated and accounts can be managed entirely online.

Student Loan Payoff

In America, 44 million students owe a collective $1.5 trillion in student loans, for those in the UK up to 83 % of student loans will not be paid in full as per the findings of this report here. Tackling this head-on, are a couple of exciting startups. One of them is Goodly, I can’t fail to mention the huge US student debt countdown ($16 trillion owed) on their homepage which quickly brings things into perspective for potential clients.

A student fresh from graduating once compared having student debt to living in a beach where there is always an active tsunami warning; you’re just waiting for something to go wrong.

Now imagine someone with this perspective on life being told by an employer that they will help them make contributions to their student loan repayment as part of employee benefits. How is that made possible? Startups in this sector like Vault, CommonBond, People Joy, Goodly, are making it happen. Handling the entire student loan management process for employers.

According to Vault, its main offering includes tools to help employees get a complete view of their student debt and using technology to model payment plans tailor-made to individuals. Vault raised $3.5 million in seed funding last year.

Goodly on the other hand also offers a customized payment and contributions plan for employees, automates compliance and reporting as well as administration for employers while charging $6 per employee.

CommonBond, another startup in the field, specializes is in trying to make the process of taking a student loan cheaper, simpler and better. The company website has an undergraduate, graduate, MBA and refinance calculator to tell you exactly what your loan will cost you.

They also take on (refinance) student loans from other lenders if you want to switch. What makes the company even more interesting to me is the social-enterprise angle it has taken by promising to fund a child’s education in developing countries; in partnership with Pencils of Promise (a non-profit that supports education in developing countries.), for every loan it funds.

As usual, when reviewing all the companies mentioned here, do your due diligence before making a commitment. One useful trick I use is checking out a company’s Facebook page and reading the customers reviews. It shows you what other users think of the company as well as their experience with them.

Go to the company’s Facebook page and look for the community section on the right side of your screen. Click the see all button (circled red in the screenshot above) and all the comments people have written to the company will be visible. Here you will know whether the company even responds to complaints-the good, the bad and the ugly.

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