Tech’s Hot New Market: The Poor | Hacker News Reader

Tech’s Hot New Market: The Poor

wired.com

Offering loans at a 330% interest rate is "helping the poor", sounds like exploitation to me. Payday lending has been outlawed in many states due to the fact that it exploits poor people and entraps them in a cycle of high interest debt. The founder of ZenFinance acknowledges that fact in one paragraph and then touts working with a company that engages in those unethical practices in the next. The following states have outlawed payday lending:

Arkansas, Connecticut, Georgia, Maine, Maryland, Massachusetts (not strictly illegal but highly regulated), New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, Vermont, West Virginia.

Source:wikipedia

I think the notion of "effective annual interest" for such short-term and small-principal loans is a little stretched, and can easily yield crazy sounding numbers. The core problem is that any costs that are fixed-per-applicant but zero-per-dollar get amortized over a very small principal amount.

Suppose, for example, that each loan application has some fixed cost for evaluation, diligence, regulatory compliance, etc. Say it's $1 per applicant, and that one in ten evaluated applications proceeds to a loan. This means that for every loan made, one has spent $10 before any money has even gone out the door to a borrower. So now consider the effective annual interest rate of a zero-profit loan for various size/duration combinations:

  1) $200, 2 weeks => 255% [100*(210/200)^(52/2) - 100]
  2) $2000, 2 weeks => 15% [100*(2010/2000)^(52/2) - 100]
  3) $200, 1 year => 5% [100*(210/200)^(52/52) - 100]
  4) $2000, 1 year => 0.5% [100*(2010/2000)^(52/52) - 100]

As you can see, even for a lender making zero profit, small durations and small principal amounts dramatically increase the effective APY. Now if you assume your borrowing costs to be zero, and all you want for profit is a 50% gross margin after the diligence costs, we'll be asking for $20 upon repayment instead of $10. The numbers are now:

  1) $200, 2 weeks => 510% [100*(220/200)^(52/2) - 100]
  2) $2000, 2 weeks => 30% [100*(2020/2000)^(52/2) - 100]
  3) $200, 1 year => 10% [100*(220/200)^(52/52) - 100]
  4) $2000, 1 year => 1% [100*(2020/2000)^(52/52) - 100]

I don't know if the inputs I used are reflective of reality ($1 per applicant, 10% conversion rate), but if they are close to accurate I think using the effective annual rates on short-term small-principal loans to call them "predatory" is misleading.

[Edit: I'll add that there's a lot of buffer for overly-pessimistic model inputs in that I've assumed 0% delinquency among accepted loans.]

It's also important to note the role of short terms here.

Consider a 2 week loan with a 10% chance of default. You need to charge an 11% risk premium to break even. Translating that 11% risk premium into an APR yields 1400%. A 1 year loan with the same default probability would have only an 11% APR.

So it's both fixed costs and division by short durations which make the APR seem ridiculously high.

Permitting payday loans sounds like allowing the poor to make decisions on their own to me. As long as the terms are clearly stated, I don't see the problem. By not allowing such lending, you are hurting poor people who are responsible and really need that money.

It's far better for a poor person to have their power shut off and pay $50 to have it reconnected than to pay $35 to someone selling financial services.

After all, moving money around provides no value, and it's usury!

My state limited the max loan rate to under 50%. The service still exists for funding for people turned away from orher services. Around Christmas it was depressing to hear the increased number of ads and the guilt strings they pull for people to take loans to make their family happy.

There is something very, very, very wrong here when the sister of a tech star states: “I’d have taken out another payday loan.”

What is wrong with it?

Similar to lendingclub and prosper except shorter terms and higher risk in terms of the risk analysis, not in terms of the social lending part.

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