Making Payday Loans Affordable.

Suresh Thotakura
Oct. 20, 2018



What is a payday loan?


Wikipedia has the following definition for a payday loan:
A payday loan (also called a payday advance, salary loan, payroll loan, small dollar loan, short term, or cash advance loan) is a small, short-term unsecured loan, “regardless of whether repayment of loans is linked to a borrower’s payday.

Brief history of payday lending

Meet Allan Jones, known as the guy who created modern payday lending industry.


In 1993, he started making these small-denomination loans against the person’s next pay-check. As of 2015, Payday Lending is a $46 billion industry in the US alone. Today, the online Payday Lending itself is a $10 billion-a-year industry.


Most of the times People need some money to cover any unexpected expenses before they get their next pay-check. It’s a stop-gap measure. They can’t borrow that money from main street banks because the main street banks require collateral. Big banks do some unsecured loans called Personal loans. But, they won’t cater to these types of small unsecured loans, as those loans would be unprofitable for them. This is where Payday loan companies fill the gap in the market. Some of the advantages of Payday loans are: they are convenient, easy to apply, no need to put any collateral to secure the loan.


How do they work?

A typical flow of applying for a payday loan goes like this:


Now, one of these two things can happen:

  1. The borrower repays the agreed amount as per the agreed schedule, life’s good for both the Borrower and the Lender.
  2. The Borrower doesn’t repay and the Lender offers to renew — sometimes automatically renew — the loan. It’s a trap!! The new principal amount for the renewed loan would be the total of “existing loan’s principal amount + interest accrued + admin fee for the renewal”. This is how Borrowers pushed into an “Endless cycle of Debt”.

Are they really evil?

While we all agree that Payday loans are a very useful service for short-term lending. However, if the borrower is not careful with his lending, then he/she might end up borrowing from multiple Payday loan companies and end up in an “Endless cycle of Debt” and their Debt situation becomes uncontrollable.

It is also the practices that Payday Loan firms follow that gives a bad name to the whole Payday Loan industry.

There is this famous racing driver named Scott Tucker ran a secretive payday lending empire. He made at least $400 million from his lending business. He funded his racing team from the money earned from his payday lending business. His payday lending business was even illegal in some states. With all Predatory Lending tactics followed by his companies, he was like this Evil Godfather of Payday Loans Industry. He was convicted for his illegal Payday lending business and currently serving 16 years and 8 months in a federal prison.

You could also watch Episode 2 titled ‘Payday’ in Season 1 of ‘Dirty Money’ show on Netflix to know more about Scott Tucker’s illegal payday lending empire.

Payday loans themselves are not evil, but the practices that these Payday lending companies follow makes the industry as a whole evil. Their greed put so many consumers and families in a very bad position.


Regulation

There was a major overhaul done in the way Payday loans are issued and repaid in the UK. The Financial Conduct Authority (FCA) in the UK proposed caps on things like: initial cost, fixed default fees, and total cost. Talk about UK regulation. For those who struggle with repayments, FCA regulation ensures that they do not pay more than 200% of amount borrowed in total.

Can we make them non-evil and affordable?



Peer 2 Peer (aka P2P) Lending comes to the rescue. P2P Lending is a practice of Individuals lending money to other individuals or businesses through some online portal. Lenders make better returns — typically 4.5% to 6% per annum — on their money compared to the savings and investments products offered by the Banks. P2P loans are generally medium-term — say 3 to 5 years — not short-term.

A typical flow of P2P Lending would be:

Its great that the Borrower will pay less interest rate compared to a Payday loans, but these are typically not short-term loans and loans are not approved instantly.

A platform that brings advantages of both Payday Lending and P2P Lending together.

Anyone would be able to go on to this platform/website and open an account. Once they have an account they could either borrow or lend or do both. No restrictions. The platform is free to join. Users have to be at least 16 years old to join the platform.

Lender flow

Borrower flow

Interest Rates

The platform decides interest rates depending on the credit rating of the borrower.


Sure, the APRs look a bit higher, but if you really think about it these are APRs are inline with some of the popular “credit building” Credit Cards. They are normally anywhere between 39% APR to 80% APR. Also, since there is no arrangement or product fee These APRs are much much lower than the typical APRs — which are in 1000%+ APRs — the predatory payday lending firms charge.


Just to put things in perspective: A borrower with a “Very Poor” credit rating pays £7 interest per month for every £100 borrowed on this platform compared to £30 interest per month for every £100 borrowed from a typical Payday Lending company. Mind you, they also have to pay arrangement fee on top of that.


The interest rate is per month and it is charged per whole month. Meaning, the borrower would have to pay the interest for the whole month even if he borrowed money only for few days.


Protecting Users’ money

Even though the platform will settle balances directly with User’s bank account. The platform still implements Segregated accounts for protecting Users’ money.


Insuring the Loans

Both Lenders and Borrowers should understand that the loan is an “unsecured” loan and should not expect any assurances from the platform itself. However, Lenders may be able to “insure” their loans by paying an insurance premium for a loan Or Lenders could insure all of their loans for year for an yearly insurance premium.


Buy/Sell Loans

The platform provides a secondary market, where Lenders can buy or sell their loans to other Lenders. This would be particularly useful, if the Lender himself is in need after lending all his money on the platform. If the secondary market is illiquid, then the Platform could try and make market and provide liquidity.


User acquisition

The platform will acquire new users organically through referrals not through marketing.

Acquiring Lenders: If a Lender invites another user to the website, and that another user transfers some money to their account on the platform, then the inviter will then earn an additional 1% interest per annum — for a year — on the money that’s sitting idle and not lent out. The interest rate is capped at 5%. That means there will not be an increase to the interest rate earned after a user invites 5 other users to the platform.

Acquiring Borrowers: If a Borrower invites another user to the platform, and that user borrows some money from the platform, then the inviter will get a discount of 1% interest on the first loan he/she takes after brining another user to the platform irrespective of the amount. There will not be any discounts after the user invites 5 other users to the platform.


Generating Revenue

The platform generates revenue by charging a commission of 15~20% on the interest earned by the Lenders. That’s the only stream of revenue. No advertising.


Licensing

Both Peer 2 Peer Lending and Payday Lending are regulated by FCA (Financial Conduct Authority) in the UK. Platform needs to be authorised by FCA before starting its operations.

Call To Action

I am embarking on this mission to build this platform that brings Peer 2 Peer lending and Payday lending together and make Payday loans affordable, and P2P lending profitable to people in the UK. It’s a win-win!!

If you are interested to join us on this mission please reach out to us.

Let’s make payday loans non-evil and affordable!

Disclaimer: I am not a Financial adviser and nothing in this post should be construed as advice.