One of the oldest and to this day most popular lending models, payday lending, faces some new twists and turns in the years to come as the legislators, and the courts continue to sort out the new payday rules.
TurnKey Lender serves numerous businesses in the payday niche worldwide, and due to our monetization model, we stay closely involved in the day-to-day of our clients. In recent years, regulators have continued their rather hectic efforts aimed at finding the optimal model of protecting the borrowers while keeping enough wiggle room for the lenders to survive.
Does the new reality create new opportunities for savvy lenders who understand how to leverage FinTech resources to maximize operational efficiencies and portfolio yield? Or is the niche all too crowded and regulated? Let’s find out.
CFPB takes lenders’ side
It looked like new payday loan regulations were set in stone when the CFPB (Consumer Financial Protection Bureau) published their Final Rule on Payday, Vehicle Title and Installment Loans in the Federal Register in 2017. But the lending industry doesn’t back out of a fight.
The companies supported some strong allies in the US Congress and a bipartisan group of lawmakers filed a joint resolution under the CRA (Congressional Review Act). This resolution states in part, “…Congress disapproves the rule submitted by the Bureau of Consumer Financial Protection…and such rule shall have no force or effect.” The resulting regulatory limbo delayed the oppressive changes for almost two years. And in 2019, payday credit providers gained an important legislative win.
This February, The Consumer Financial Protection Bureau proposed rolling back the provision of an Obama-era lending rule designed to protect people taking short-term, high-interest loans. The new rules loosen the grip on the lending industry. Lenders won’t need to confirm that their borrowers can repay the loan if that fits within their business model. The elimination of the “ability to pay” requirement affects loans with a term of 45 days or less. It also would target single-payment loans with vehicles as collateral and even some longer-term loans. You can check out the full document here.
But worry not, it’s not as onesided as it sounds. Borrowers can still open an account with a credit union or community bank which are exempt from the CFPB rule.
Let’s get back to the people
To not get bogged down in the complexities of Washington’s political manipulations, let’s stay focused on the people these loans are designed to serve.
The Pew Charitable Trusts has conducted extensive studies on payday borrowers and how they use the funds. According to Pew research, 12 million Americans use payday loans each year, and some use the service multiple times during the year. 5.5% of all adult Americans have used a payday loan at some time, and this number almost doubles to 9.0% when you look at the 25-29 age range.
It’s interesting to note that the demand for mortgages in the US ranges from 9.0% to 18.2% depending on the state. So one may even say that the need for payday loans is equal to the demand for mortgages. Of course, the argument that payday loans form an addiction similar to that of credit cards stands to reason. But we believe that things can change. Platforms like TurnKey Lender lowering the lending industry entry barrier, it gets easier to start and run a payday loan business, the operational costs decrease, and interfaces both for lenders and the borrowers get intuitive. All this leads to the market finding a balance that suits all the parties. Borrowers get a lower interest and better conditions, lenders get to still work at a profit without the monstrous fees and interest.
What you need to know about today’s typical payday borrower
Pew describes the typical payday borrower as a single female, age 25-44, who heads a household with two minor children. She likely has no college education, works at a minimum wage position, uses the funds to cover unexpected emergencies, and pays off the loan within the specified payment period.
About 15% of payday borrowers use the funds to cover everyday living expenses. They’re likely to roll over the loan at the end of the payment period or take out a new loan in a short amount of time. This frequent borrower pays an extremely high APR as they recycle the same $350 up to 7 times during the year.
Contrary to legislative opinion, this consumer weighs the pros-and-cons of the limited number of credit options available to them. And they see that the payday loan is their best alternative when compared to a high overdraft fee if a check bounces, or a $500 deposit for a secured credit card. Plus the secured credit card will likely charge a monthly maintenance fee on top of an interest rate as high as 35%.
The ongoing debate about the morality of payday loans
It’s no secret that many legislators in the US keep trying to limit the supply of payday loans by imposing onerous new policies on lenders. This approach is ultimately flawed because it doesn’t address the underlying cause of such high consumer demand for these loans. As long as the primary payday borrower is a single mother working to support two children on a minimum wage that’s just at or slightly below the poverty line, then the demand for small, short-term loans will remain high.
The argument often used against the payday industry is that the interests are just too high and that the lenders make money on the borrower’s money problems. The answer to this one is straightforward: lenders have no choice but to determine interest based on risks they take on issuing any loan. As long as a theoretical single mother is running a high risk of not having enough money to pay back the lender, the interests will be high. Pressuring lenders into working at a loss is no way to help the borrower live better.
At the same time, the lending industry isn’t unsympathetic to the pains of the payday borrowers. The only way for the lender to lower the interest and still work at a profit is to make safer and less generalized credit decisions. In today’s technological environment, this can be achieved through the use of an intelligent lending automation platform. TurnKey Lender’s decisioning engine is powered by deep neural networks that learn about the clients of each lending operation and adjust to approve more of the safe borrowers faster. And as we can see on examples of our clients, this does benefit both the lender and the borrower.
There’s no denying that often the people who use payday loans are the ones who struggle. But that’s the way the market operates – demand needs supply. Lenders fill the market gap. And once the average person makes more money and lives better, the interest will go down and the payday loans will get cheaper for the borrower.
Payday business model isn’t simple
From the regulators’ perspective, the situation looks simple. Payday lenders charge the most vulnerable sector of our exorbitant society fees and interest rates for small loans. So why can’t community banks like credit unions step in and offer the same loans with lower APRs?
Unfortunately, the business model isn’t as simple as it looks. According to the CFPB, the average payday loan is $350, and it’s paid off within a few weeks or a few months. The profit earned on an individual loan is minimal, even though the interest plus fees when calculated as an APR looks exceptionally high.
Payday lenders tell us their ROI is much lower than the APR. Dennis Shaul, the CEO of the CFSA (Community Financial Services Association of America) was quoted in a CNNMoney article saying, “We’re making about an average of 4% return on investment. We’re not making an obscene profit on the backs of people.”
The NCUA (National Credit Union Administration) approved a new type of loan in 2010 called a PAL (payday alternative loan). It allows their member banks to issue small loans ranging from $200 to $1,000 with terms ranging from 1 to 6 months. There’s a $20 limit on the application fee, and the loan cannot be rolled over at the end of the term. The APR can be as high as 28%, but borrowers can reduce their rate down to 18% by automating the payments via direct deposit.
In 2016 only 20% of credit unions offered PALs because the stringent terms make it difficult for the typical credit union to break even on the transaction. The major problem is high operational costs due to legacy origination and payments processing systems that are overly manual. And these problems fade in the past for the savvy lender thanks to software platforms like TurnKey Lender.
Untapped opportunity for FinTech savvy lenders
FinTech savvy lenders enjoy the unique ability to issue small, short-term loans with borrower-friendly pricing — and still, make a profit. The long-term demand for these loans will remain high. Regardless of whether the financial vehicle is a payday loan, title loan, or check cashing service. And regardless of the nature and strictness of the regulation.
We believe this ongoing demand represents an untapped opportunity to offer a payday loan alternative that’s socially conscious and still profitable. Several niche groups within the financial services industry could capitalize on this opportunity, including online lenders, crowdfunding platforms, microlenders, small local banks, community banks, and credit unions.
The key to profitability is booking a large number of accounts and managing them efficiently. So the successful lender will understand how to leverage FinTech resources like TurnKey Lender to create hyper-efficient processes for loan origination, loan decisioning, funds transfer, and payments processing.
FinTech lending platforms are optimally suited for small, short-term loans for two reasons.
- They use automation to gain operational efficiencies, which reduces costs.
- The top FinTech lending platforms use advanced credit scoring methodologies to improve credit decisions, which increases portfolio yield and profits.
Looking at the market globally, it’s clear that now is the right time for lenders to capitalize on this large and lucrative loan category. And to make sure you are head and shoulders above the competition, reach out for a free trial and a demo of TurnKey Lender to see precisely, what we can do for your business.
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