

Tech’s Hot New Market: The Poor  - cyphersanctus
http://www.wired.com/business/2013/01/techs-hot-new-market-the-poor/

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kristenlee
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

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_dps
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.]

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yummyfajitas
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.

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

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amalag
What is wrong with it?

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amalag
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.

