Fixing what’s broken about payday lending
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Given that my company will be affected by the Consumer Financial Protection Bureau’s proposed payday lending rules, we were, perhaps not surprisingly, met with some initial skepticism after announcing our support of them. 

The rules have sparked a heated debate about the short-term lending market and how best to serve the millions of underbanked Americans who rely on it. Payday lenders have said the proposed rules will deprive these consumers of small-dollar loans. We know this isn’t true because our model incorporated many of the CFPB’s proposed practices from the beginning: extensive underwriting of ability to repay, no rollovers (i.e., the payday “debt trap”), a series of notifications before we collect payment, and more. 

Right now in America, a full 56 percent of the population—more than half of the country—can’t access mainstream credit products because their credit scores are too low. Imagine living paycheck to paycheck and being so shut out of a financial system that, if your fridge breaks, your tire pops, or a bill comes due before your next paycheck, you have no financial backup—not even a credit card to bridge the gap. Banks typically just do not lend to people with a credit score under 680.

For many of these people, small dollar, short-term lending offers one of few real solutions for their financial needs. Unfortunately, the market is fraught with predatory and abusive practices that can trap borrowers in a cycle of debt they can’t escape.

Prime customers benefit from products where a track record of on-time repayment means better terms over time. Whether your rates go down, your credit limit goes up, or you qualify for more rewards, your product gets better. In the payday market, the reverse is often true. Instead of getting better, payday loans can get worse. In fact, many lenders count on customers going past due and paying extra fees. These dynamics have warped traditional payday lending beyond the point of self-correction. 

The CFPB’s new rules seek to trigger a critical reset by eliminating these debt traps that so often result in consumers paying more in fees than they ever got in principal. The proposal prohibits expensive rollovers of the same loan and restricts seemingly never-ending fees—charges that too frequently cause consumers to have their vehicles seized and bank accounts closed. Equally important are stronger underwriting standards for assessing ability to repay, provisions that would in any other industry be a given but, in the penalty-driven world of payday lending, threaten profit margins. Finally, the fact that these rules will make all lenders, including those who incorporate on tribal grounds, provide consumers with the full protections of federal and state laws, is one of the biggest wins for consumers. Less regulated entities have invented some of the most abusive practices and monetization schemes in financial services.

Predictably, entrenched industry players are crying foul, arguing the current small-dollar model reflects the economic realities of subprime lending. We couldn’t disagree more. Through technology and innovation, we’ve seen firsthand that a market-based solution that expands access to credit and lowers borrowing costs over time is possible.

The rates of the entry-level product serving our riskiest customers are similar to those of payday loans. These customers have either a damaged credit history or no credit history at all, and that high risk means commensurately high interest rates. But, unlike payday lenders that stick borrowers with the same expensive rates over and over regardless of repayment, our goal is to lower the risk of our borrowers through education and repayment history. Thus we graduate borrowers to loans with lower rates over time where the LendUp Ladder is available. We’ve also eliminated rollovers, cut out hidden fees and made free financial education a central part of everything we do. 

We are still scaling our model, and the early results are encouraging. We estimate we saved our customers more than $16 million in 2015, and have already saved them another $18 million in 2016. More than 90% of active users who have been with us for two years have access to credit-building loans. We have also taken customers from having credit scores in the 300s two years ago to having a credit card today, which has a zero interest borrowing cost if paid on time and in full. 

We believe it’s time all short-term lenders learned to align their success with that of their customers, and we know that it can be done sustainably. That some in the payday industry disagree—warning that curbing predatory practices will lead to restricted access to credit—is reflective of the troubled state of the market and a clear indication that the proposed rules are needed.

Sasha Orloff is the CEO and co-founder of LendUp, a Silicon Valley-based financial services company with a mission of providing anyone with a path to better financial health.