I hope they post a response, and this turns out to be some kind of misunderstanding.
I do really appreciate the quality of analysis Modern Microlending did here. It's also great that Zidisha responded within hours with a pretty full and honest accounting. This is how this kind of thing is supposed to work, I think.
APR is enforced to keep lenders from disguising the real costs of a loan using fees and such. It's an ethical advertising standard. But, disguising the real costs of a loan is not the only reason to use fees. Fees are also used because the lenders' costs are not just borrowing costs. There's a flat cost to processing a loan. That translates to a flat fee which can raise APR to seemingly horrendous rates.
Basically, loans don't scale linearly.
Maybe micro-finance should come up with it's own standard practice. People need to make some allowances though. 25% is not terrible in every context.
They're following the status quo, are probably not intending to be evil, and are surely feeling the pressure to be 10x better.
But I worked in the Philippines in college, and you want to know what would really blow their minds? Not screwing them over. Everybody else does that. 10x better is being honest. Given their alternatives, 25% isn't that bad. Initial adoption might be slow - they're so used to corruption and being bullshitted that they'll think it must be 25% plus something - but once word spreads that Zidisha is really just 25% and offers the most valuable commodity in places like this - honesty and transparency - it will blow up. And then you'll get more fraud, but that's challenge 2.0.
This raises the question of why Zidisha is making these statements. To assume a developed-world business context excludes the possibility that these practices are accepted and commonplace in the markets Zidisha serves. I have no experience with those markets, but it's worth excluding this possibility before expressing distaste for these practices.
Consider the following plausible scenario: Zidisha performs research into the market and discovers that these practices and rates are acceptable. One can even imagine they are preferable to the status quo. The issue is that Zidisha as a company has to generate press and justify its business to a developed-world audience whose gut reaction to such practices would make the company look like a pack of usurers, when in fact they could very well be doing a lot of good.
To me, this communication seems a compromise response to this conflict: translate the numbers and practices as best you can into language and terms developed-world audiences understand. Perhaps the company took some liberties with labeling and conversions along the way, and if this is the case they would do well to be more conservative, but overall I give the benefit of the doubt that this communicate is the result of a tricky conflict of business environments rather than deception.
Can't it be both? Intentional misrepresentation in the pursuit of a worthwhile goal is still intentional misrepresentation. I look forward to seeing Zidisha's response, but as it is this looks highly intentional and highly deceptive.
This ultimately comes down to the classic "do the ends justify the means" debate. It also leads to immediate suspicions of a slippery slope - if the founders of this startup are willfully misrepresenting the core nature of their business in furtherance of their goals, what else about them is negotiable?
In fact, flat rates are more confusing because they are misleading. So, not only is Zidisha joining in on this customary practice, they are promoting it.
Instead, they should educate their clients, re-express competitive rates in terms of APR, etc.
So, the net is that it does appear to be intentionally misleading, which is made no better by the fact that such misleading may be common practice in some parts of the world.
Although I do not agree with Modern Microcredit's allegations that we are intentionally misleading, the discussion that has resulted is a useful one.
As I see it, we have a several options:
1. The status quo: Continue to quote flat interest rates in our website along with an explanation of the calculation in a modal box, and display the dollar amounts paid for each loan for extra clarity.
2. Transition from a flat rate methodology to APR. This would be more in line with the standard used in most lenders' countries, but would be more difficult to understand for borrowers. (It would also require a rewriting of much of our website. Zidihsa has only one web developer, so implementing this option would probably have to wait until have more programming resources.)
3. Continue to use flat rates as the basis for calculating the cost of Zidisha loans, but display the equivalent APR rates along with them. Perhaps Microfinance Transparency could help us develop a tool to facilitate this.
4. Continue to use flat rates, but use the term "fee" instead of "interest." This would be easy to implement and could help lenders avoid mistaking our flat rates for APR, but makes cost comparison with loans in borrowers' countries less straightforward.
Zidisha has little value without transparency, and those who have commented here obviously care deeply about it. I'd welcome everyone's advice on which option Zidisha should adopt, or alternative proposals.
This statement implies bad-thinking with regard to borrower clarity and understanding. As is well-known and obvious, flat-rate pricing actually obfuscates the true costs. So, to say that it helps borrowers understand is to say that it purposely gives them a false sense that they understand when they actually do not.
Again, this is obvious, and anyone who understands APR and its purpose must make this admission. And, if one makes this admission and still continues to promote flat-rates as somehow clearer to borrowers, then he/she must also admit that he/she is now willfully misleading borrowers for whatever purpose ("simplicity", self-interest, or otherwise).
Huh? Flat-rate pricing makes the true cost absolutely clear. If you have N payments with an k flat rate, and principal P, the total of all payments will be P × (1+ k × N). The "true costs" with APR are no more clear.
Declining balance interest (APR) is perhaps a more fair and economically efficient basis for charging for credit, but its not at all more clear as to the "true cost".
Perhaps you're using the "generic" definition of APR, whereas the article, most on this thread, and myself are using the U.S.-definition of APR. That is, APR would include fees and non-interest charges.
On a pure mathematical calculation basis, I don't believe either is particularly difficult to understand. It's just that excluding fees--as is is done in flat-rate pricing of the ilk described by the article--is misleading vs. more inclusive APR calculations.
Insofar as "substantial fees attached that are not included in the quoted flat rate" obfuscate the costs, that has nothing to do with flat rate interest (obviously.)
As I mentioned in my response to your comment above, you appear to be using the "strict" (mathematical) definition of APR vs flat-rate calculations. In the U.S., APR is generally understood to be inclusive of up-front fees as defined by the Truth In Lending Act.
Whether or not this is perfect in practice, on this thread (and in the article), the term APR is meant to convey a number that is inclusive of all fees and non-interest charges, such that it reflects the truer cost of the loan.
Your bank won't lend you $50 as a loan. It's not worth it for them. But if you add in some reasonable fees (like $11 for credit check report), an $11 one-time fee on a $50 loan converted to APR looks huge! 500% APR! But it's only because the amounts we are talking about are so small.
I think we need to look at this more carefully and not compare apples and oranges. Big loans and small loans are different things.
(And payday loans are evil. But microlending is not the same as that.)
Your example is fine, by the way. Yes, that $50 is costing you 500% APR. And yes, that is exactly how you should think about it, and how they should advertise it. Anything else is problematic. It doesn't matter how the cost is arrived at, this is the cost to you of borrowing that money, and it is this entire cost that must be balanced against the value you will see from it, not any nominal rate.
There is absolutely nothing wrong with doing the sort of loan they are talking about, and the costs may be perfectly reasonable too; certainly microlending is a different risk landscape that typical bank loans.
However, the only ethical way to handle financial details like this is to always be as transparent as you can.
Lots of sectors get this wrong, by the way -- payday loans are particularly egregious but the auto finance industry is pretty slimy on this too, in different ways.
By the way, payday loans as an institution obviously meet a lot of market need that wasn't being addressed before them, or they wouldn't have popped up everywhere. I don't think they should be run out of town, but they should be honest about the costs.
This is true that the auto industry (some anyways) will extend the life of your loan to make the car look cheaper. You can only afford $100 a month? Have a ten year loan! However, I was with a friend when she bought her car and on the finance agreement there was a (possibly legal requirement) box where it said clearly "this is the total amount of interest you will pay over the life of the loan." You had to sign that you got that number and that it was pointed out to you. Regulations in the US make lenders less scummy.
I'm the director of Zidisha, and have just posted this response to the blog post. I'd be happy to respond to questions here.
Dear Modern Microcredit,
I'm sorry that you found our website information misleading. I'd like to address your points here:
1. Interest rate diagram: As we do apply a 5% transaction fee, I agree that the diagram showing a range of 0% to 15% is incorrect. A volunteer had donated the diagram to us years ago, and we did not scrutinize it sufficiently before using it in our website. We have now removed the diagram until it can be adjusted to reflect the 5% minimum cost.
2. Registration Fee: This is approximately $12 paid when a borrower first joins Zidisha, and provides lifetime membership. We do not include it in the interest cost calculation because it covers the unlimited number of loans that borrower may receive over the course of many years.
3. Zidisha service fee: This is a flat 5% of the loan amount per year the loan is held. Most Zidisha loans are held for less than a year, so it is usually less than 5% of the loan amount. For example, the 5% fee for $50 loan held for three months would be 1.25%, or about 63 cents. That is hardly exorbitant.
4. Interest offered to lenders: We allow borrowers to offer any interest rate they choose to lenders, from 0% up to a maximum of 25% of the value of the loan per year the loan is held. In practice, the highest rates are usually offered by first-time borrowers who have not yet established track records with Zidisha (much as new eBay sellers offer the first few items at a discount).
5. Using a collection of randomly selected loans as a proxy for average cost to Zidisha borrowers is misleading. First-time Zidisha loans are overrepresented in this measure, because they are smaller and repaid more quickly, and are therefore more numerous than the larger subsequent loans taken by established borrowers. Since first-time loans pay the highest annualized interest (because they are held for a short time), using them as an example overstates the average cost of Zidisha loans. Our statistics correct for this by using a weighted average based on dollar amounts rather than single loans.
6. We use flat rates not in order to deceive, but simply because they are more intuitive to borrowers and lenders than APR. The vast majority of our borrowers are used to flat rates being quoted by local lenders, and when they tell us they want to borrow $100 at 10% interest, they mean that they wish to repay $110. If we wanted to distort our data to appeal to lenders, it would make more sense to use APR, as the higher quoted rates would make lending through Zidisha seem more profitable. In fact, our intent is simply to make the cost easy to understand for everyone. For extra clarity, we provide extensive explanation of APR vs. flat rates, and display the exact dollar amounts borrowers pay for each loan in the loan profile pages. I don't see how this can be construed as hiding information. Using APR in Zidisha's situation would mean sacrificing a measure that the majority of our members understand easily for theoretical precision.
7. You imply that Zidisha does not in fact lower the cost of microloans in developing countries. That is not true. Even the $50 loan you cited above, which chose to offer to lenders the maximum interest rate we allow at Zidisha, ended up costing the borrower only $1.73 in interest and fees. I would be surprised if any other lender would offer an online applicant with no credit history a short-term loan at such rates.
Zidisha's cost savings to borrowers have been independently analyzed. Below is an excerpt from a study published by microfinance analyst Daniel Rozas. (Note that the average interest borrowers have opted to pay lenders has increased from 2-3% at the time of this study to about 5-6% currently, but this does not invalidate the conclusion that Zidisha's rates are substantially lower than what has hitherto been available.)
Zidisha’s interest rates are remarkably low, ranging between 7-8% annually (quoted flat), of which 2-3% is charged by lenders and 5% is levied by Zidisha to fund its operations. An additional fee of some $10-20 is charged for initial registration (but not for subsequent loans). This is far below the local prevailing rates – MFTransparency places similarly-sized loans (50,000 KES) at about 35% APR (Zidisha’s loans are 15-18% APR). And it’s all the more noteworthy, considering that Zidisha’s borrowers are largely in rural areas, where credit tends to be more expensive. The key to the low rates rests on Zidisha’s avoidance of costly staff and operations on the ground, and its ability to leverage low-cost funds from socially-motivated lenders. (from http://www.financialaccess.org/blog/2011/07/microfinance-wit...)
I'd be happy to provide further information as desired.
As founder of Microfinance Transparency, I know very well how confusing pricing can be, due to a combination of confusion of what definition we are using and because of the biases each speaker uses in choosing a definition.
Annualized rates like APR were designed to avoid both flaws. No ambiguity about sentences like "when they tell us they want to borrow $100 at 10% interest, they mean that they wish to repay $110." An APR gets around the ambiguity of how long the client has $100. An APR gets around the ambiguity of if they have the $100 for the entire time or are paying back some of it.
It is an undeniable fact that lenders did not invent flat interest to make things easier for borrowers. They invented flat interest to make the price look cheaper to borrowers. When that abuse comes to light, Truth-in-Lending legislation comes in to defend clients. I expect Zidasha believes more in defending clients than spinning the data for both funders and the clients, but the current policies are arguably more like spin.
I suggest one path forward on this, as I did when you and I spoke March of last year - MFT can provide a legitimate and unbiased method for Zidasha to use to calculate prices, so that the prices you publish more closely reflect true prices.
Thanks for this comment. I'd welcome the help of MFT to develop an APR calculation tool for Zidisha loans. I've just sent you an email, and look forward to discussing further.
I'm a consumer finance attorney who has worked for several years with people from all over the income spectrum who have trouble with finances. No one -- and I mean no one, not federal judges, not banking attorneys, no one -- really understands what APR actually means. It's useful in the US, though, because it means that all borrowing products are calculated the same way, so a consumer can compare the cost of credit from one product to another and it's truly apples-to-apples.
Keep the flat interest. As you say, this is what your customers are used to and it will allow them to make meaningful comparisons with sources of credit in their own markets. An APR will only confuse people and be misleading.
For what it's worth, I'd take the one-time application fee out of the cost of credit calculation and put it down below with an asterisk, like "if this is your first loan with us, there's also a one-time fee of $11 to cover the costs of ___."
I can go to any mortgage calculator online and plug in some simple numbers and get a breakdown of my payments every month, interest on the payments, and total interest paid and I now know how much I am and will pay. This isn't hard, when it isn't done it is to hide information from the consumer.
That's like saying nobody should save because nobody understand compound interest. It is true that hardly anyone understand compound interest (and how amazing it is).
When I first visited Zidisha's site (a couple of weeks ago) I spent some time reading through the fine print and discovered the same thing that ModernMicrocredit did: that the way you presented things was highly misleading about actual prices paid by borrowers. (The fine print, of course, was accurate, or I assume it was.) But your choices were made in order to convey things more clearly (to a different audience).
Presenting rates two different ways: using your existing system system based on flate rates AND ALSO an "APR" (calculated according to Western banking practices and including both interest and fees) might meet the needs of both audiences, so long as you can present it in a way that is not confusing. Similarly, show "Average Lender Interest" but also nearby show "Average Borrower Interest".
By the way, at the time I did NOT invest through Zidisha (although I made a note to come back later and reconsider). I am interested in microfinance, and the way you were running it seemed quite appealing; the main reason I did not immediately participate was this issue of misleading presentation of the loan costs to the borrower.
Thanks for sharing this. What if we were to continue to calculate interest and fees using our current flat method for the time being, but display the equivalent APR to lenders and borrowers? As a prospective lender, would this have addressed your concerns about transparency?
I work in the US mortgage industry where advertising of "APR" rates is mandated so consumers can easily compare different offers. Mortgages are still permitted to have all kinds of odd financial arrangements: fees and fee-like structures (points), negative fees (cash-back refinancing, negative points), different payment schedules (interest accrued in advance or in arrears, monthly or biweekly payment schedules), and much stranger things (balloon mortgages, even reverse mortgages), and also many things vary from loan to loan (for instance: some costs vary according to which county you live in).
All of that complexity gets baked into the APR. Fees are amortized over the life of the loan (or sometimes a shorter period). Various kinds of rates get boiled down into an annualized APR. This is far from perfect: no single number can make all that complexity truly comparable, but it roughly does it's job. Each individual loan has an APR calculated once its rates and fees have been set, and marketing messages must quote APR using a sort of "typical loan" for that lender. I think you could develop a definition for "APR" that handled the flat payment method but made it comparable for someone like me.
1. All cash flows which are non-optional from the borrower's perspective are included. This includes one-time registration fees.
2. The rate in annualised to make loans of different lengths easily to compare.
3. Advertisements must include the APR that 66% of borrowers who respond to that specific advert will get. For example, if you expect that a specific advert would generate 100 customers, and the resulting loan offer APRs would be evenly split between 20%, 25%, 30% and 100%, then you would quote 30% APR on your advert.
Excluding one-time registration fees from the APR and total cost illustration is IMO misleading if an ad is mainly targeting new borrowers. The same goes for weighting the APR by loan amount, as this weighted rated can be far from the APR for new borrowers (who, because they are more risky, will get smaller loans).
I have no specific knowledge of your company, and my comments above apply equally to any consumer lending business.
I had never heard of 'flat rate' vs 'declining balance' interest rates. As far as I'm concerned, it's abusing the word to call your fees an 'interest rate' because they are not. They lack the necessary property of a 'interest rate', that is, being based on balance over time. What you are charging is a fee, based on the starting balance and period. I think you should stop calling this an interest rate, and I'd be surprised if it's not illegal to do this anyway.
It sounds like your 'service fee' is ALSO a flat rate fee based on the starting balance and period, which makes splitting it out and consistently footnoting it in your marketing seem deliberately misleading. The reason we insist on APR is because you can't hide anything from it. When lenders make up terms and market them, it's almost invariably because they are trying to hide costs. Somehow this cost hiding is always couched as 'better for the borrower'.
The "it's only 63 cents" trick won't work with this crowd. Because we understand how "interest rates" are supposed to work. If it's just 63 cents, then easier to refund it than write the blog post. But 5% of $2m is $100,000 so lets get real.
MMC includes a screenshot showing 'About this Loan' a few times during the article;
Amount Requested: USD 50.00
Repayment Period: 6 weeks
Grace Period: 1 week
Offered Interest Rate: 25.00%
Service Fee: 5.00%
One-Time Reg Fee: USD 11.78
Total Amount (Including
Interest and Transaction USD 51.73 (30.00%)
Fee) to be Repaid:
If you can get users to pay the 'Registration Fee' completely independently of getting a loan, then by all means, have them pay it separately, and keep it out of the loan statement. But, what I imagine really happens is, users pay this fee to get a loan, then it's a loan fee, and you have to include it when you do things like report your total loan costs!
Am I understanding correctly that you are suggesting we not use the term "interest", but instead call the amounts borrowers pay to lenders a fee?
That is worth considering. It would avoid much of the confusion over flat rates versus APR, and would still be clear to borrowers that the amount represents the cost of the loans.
I'd be interested to hear others' perspective on whether Zidisha ought not to use the term "interest" at all, but instead replace it with "fee" or some other term.
If borrowers want to know how much they are paying in interest rate, then I think you should tell them in terms of APR. If borrowers want to know how much they are paying in terms of dollars, then that's easy, just tell them.
I think itemizing out fee A, fee B, fee C, is just a silly game. If you go back to your "About this Loan" table, what you call 'Service Fee' and 'Interest Rate' are the same thing, just combine them. Then, if I want to know how much they actually cost, I have to look at Total and subtract $50? But then it's still missing the "one-time fee".
What if the table did say; (and I'm not saying you should do this)
Loan Date: April 14, 2014
Repayment Date: June 2, 2014 (7 weeks)
Amount Requested: USD 50.00
Loan Fees: USD 13.51 (200% APR)
Total Amount: USD 63.51
The only problem with this is it doesn't really help me understand how much it's going to hurt if I need more than 7 weeks to repay. But I don't know enough about your payment model to really comment on that.
Loan Date: April 14, 2014
Repayment Date: June 2, 2014 (7 weeks)
Amount Requested: USD 50.00
Loan Fees: USD 1.83
One time fee: USD 11.68 (one time life membership fee)
Total Amount: USD 63.51
This makes sense, and we are already doing some of that.
In the loan application form that borrowers see, the 5% fee to Zidisha and the interest offered to lenders is in fact combined. Borrowers choose any combined rate from 5% up to a maximum of 30%, with a text description indicating that the first 5% of this is paid to Zidisha and the rest is paid to lenders.
The loan application page also indicates the registration fee, as a cost separate from the combined interest / fee rate that the borrower selects.
We separate the service fee from the lender interest in the loan applications that are displayed to lenders, because the intent is to indicate the maximum interest that they can expect to receive from each loan proposal.
That is, the real issue here is that the true rate/cost is not reflected clearly in the interest as currently presented. So, the real solution here is not to introduce a new, ambiguous term, but to use the traditional and well-understood term for conveying the true cost of a loan; that being "APR".
Of course, by definition, you'd then necessarily include in that number the true costs of the loan.
The one-time registration fees seem like the most suspect thing to me. As you're a non-profit, would it be possible to raise more money from foundations and other donors if you got rid of the registration fee? Do borrowers find the registration fee onerous? Does it serve some other purpose (limiting nuisance registrations, etc)?
It would certainly be possible to eliminate the registration fee, and make up the difference with a slightly higher recurring service fee. (We are not yet supported by any major foundations.) There are two main reasons we have not done so:
1. As a small nonprofit with limited financial resources, one of the measures we've adopted to ensure that we always have enough cash to cover our costs as we grow is to couple service fees closely with actual expenditures. There was historically a large up-front cost to admitting new borrowers, as we used to contract with local partners to verify applicants' credit histories with local lenders. We no longer work with local verification partners, but even today there is an up-front cost in Skype and SMS charges, as we verify the information of new borrowers with local contacts. Coupling registration fee income with the cost we incur to admit new borrowers ensures we will always have enough revenue to cover our costs, regardless of the pace at which Zidisha grows.
2. Shifting a portion of the costs borrowers pay to join Zidisha to a lifetime membership fee paid up front makes strengthens the incentive to participate responsibly with Zidisha over the long term, because costs of borrowing decrease as members build up a track record of on-time repayments over time.
Could you clarify?
Yes, that is true: loans held for less time pay less, and a loan at 5% held for 2 years would pay 10% of the principal.
Using flat rates instead of APR does result in loans that cost disproportionally little when held for short periods, and disproportionally much when held for long periods. The greatest concern are cases in which a loan for an initially large amount is held for a long time after most of the initial amount has been repaid, resulting in interest calculated as a flat percentage of the original amount being applied even though most of it is no longer outstanding with the borrower. Avoiding such situations is probably the strongest argument for changing from a flat rate to an APR methodology.
We have not done so because such cases are not very frequent, and because we judged that the value of having a simple and intuitive cost calculation method outweighed the value of having a more precise model that the majority of our members would not understand in practice.
Many of the new cool SaaS businesses try to do that. Most banks, mobile phone shops etc. don't.
Edited as I'm seeing that you're kinda defending your company from some strongly worded allegations. I just commented on the general state of the world, and didn't mean to attack you or your service.
Do you mean this page? https://www.zidisha.org/microfinance/borrow.html
How would you suggest modifying this to make it more transparent?
A calculator like Shipwire uses to help people calculate the cost of their fulfillment services: http://www.shipwire.com/pricing would be ideal, but you'll run into very old browsers in those internet cafes. So even a more demonstrative infographic would help borrowers see just what's being offered.
I really hope you guys succeed, I've just worked with people who could use what you're offering and have seen them disappointed too many times by offers that were either misleading or that they just didn't understand.
You can propose any interest rate between 5% and 30%. The first 5% goes to Zidisha to cover money transfer fees, and anything above that goes to lenders. Lenders who find the proposed interest rate reasonable can choose to fund the loan at or below your proposed interest rate.
In addition, new applicants who succeed in raising a loan pay a one-time registration fee, which is deducted at the time the first loan is disbursed.
View current registration fees
"View current registration fees" displays a modal box with the registration fees applied in local currency in each borrower's country. (These are currently about $12 in Kenya and Burkina Faso, and zero in the other countries in which Zidisha operates.)
Our loan application form does provide a cost calculator to borrowers, though it does not use the term APR. The loan application form works as follows:
1. The applicant specifies the amount he/she would like to borrow, and the combined interest and fee rate he/she would like to offer.
2. The applicant specifies the local currency amount he/she prefer to pay each week or month. (Our website advises selecting the largest installment amount one can comfortably pay in order to minimize interest cost.)
3. The applicant chooses the day of the week or month he/she would like to make payments.
4. Based on this, our site generates a display of the local currency principal and fee/interest amounts that will be due, along with a projected repayment schedule.
5. The applicant can go back and modify the proposed loan parameters until he/she is satisfied with the cost and repayment schedule displayed, and can then publish the loan application on our website.
6. Lenders can fund the loan at rates between zero and the applicant's offered rates. In practice, many lenders opt to fund loans at low or zero interest, such that most applicants receive the loans at lower interest than what they had proposed.
> You can propose any interest rate between 5% and 30%. The first 5% goes to Zidisha to cover money transfer fees, and anything above that goes to lenders.
but then, on the next page you say that I need to pay 1.75$ for money transfer fees. What is the problem there? Why do I have to pay this fee multiple times? Will I also be charged that fee again when people start paying off?
Look, the idea of microfinancing is nice, but the way you play with the numbers in order for them to "look better" is just to scammy. In the end of the day, I just can't trust you anymore that the money really goes where you says it goes if you can't come up with the clear upfront cost breakout without playing games. If you are not playing games, but simply not understand how this looks like, then please just shut down and stop poisoning the good idea with atrocious presentations.
These are two separate costs. The fee for lenders offsets the cost of receiving their funds via PayPal or credit card. It is set to match as closely as possible the average transfer fees that our organization pays to PayPal and Stripe.
The 5% charged to borrowers covers international money transfer costs, and the cost we pay to local payment services in each borrower country. This fee is also set to match the average money transfer cost we pay across all countries.
We use two separate fees because it allows us to ensure that we receive income at roughly the same time costs are incurred. This helps ensure we always have enough cash flow to cover our costs, no matter how quickly the organization grows.
If you displayed your flat rate numbers into APRs, then I wouldn't have any problems with your marketing. You could compare your average Zidisha APR of 25% to the average industry average of 35%, and lenders could make their own informed decisions.
I agree that deleting that interest rate diagram is appropriate. However, you have repeatedly
compared your low flat rates with high APR rates elsewhere on your site. For instance, in this page on your site, you say, "While other microfinance services charge borrowers interest rates upwards of 40% or more, our direct peer-to-peer microlending model reduces the cost of Zidisha loans to just a fraction of this." 
Statements like these lead to articles comparing your low flat rate to others' higher APRs. [2-5]
To me, comparing your flat rate numbers to other people's APRs feels like a deeply misleading comparison.
I'd like to hear your side of the story here. Perhaps I'm missing something.
Thanks for commenting here. I wish you had asked for our side of the story before publishing these allegations.
I agree that flat rates should be compared to flat rates. It would indeed be misleading to compare Zidisha's flat interest rates with another microfinance provider's APR rates.
In my experience, flat interest and fee rates of over 30% are common in microfinance, and that was the basis for the comparisons I have made with the cost of Zidisha loans. It is hard to find reliable data on the average APR of microloans worldwide, because many microfinance organizations underreport the full cost of their loans, and those that do opt for full disclosure on sites such as Microfinance Transparency and the MIX Market tend to be those with the lowest rates.
This article provides a good overview of some of the complications involved in measuring the cost of traditional microfinance loans: http://blog.givewell.org/2010/04/02/microfinance-interest-ra...
I don't know much about finance, however something that's always struck me as odd is that companies such as your own don't have a simple graph - with money owed on one axis (everything the borrower would be expected to pay you, fees, interest etc) and time on the other, perhaps with options to adjust the graph for different payment schedules.
You could still include the usual stats about interest rates and so on alongside this - but it seems to me that way of looking at things would make it simpler for those who have difficulty calculating the effects of fees, various ways of interpreting interest rates, and so on.
Thanks for your time :)
Great reply. I am a fan of Zidisha and what it is trying to do. Having grown up in a third world country to very poor parents with minimal education, I am fan of any initiative that helps the poor and the willings everywhere. I wouldn't be where I am today without the support of a few benefactors who came along in my life time to time.
I hope you will not make any major changes to your service based on comments and blog post. Bystanders shouldn't drive your business decisions.
If your borrowers understand flat interest rate better then you should be using flat interest rate with your borrowers.
From traditional lending perspective, registration fee is nothing more than application and origination fee. Actually, your fee is much lower than 3-5% origination fee charged in lending.Though your service fee (loan administrative fee) of 5% is two to three times more than traditional 1-2% administrative fee. Considering how expensive international money transfer is your service fee is reasonable.
As for lenders, if they want to see feel good stories of how their money helping someone that is what you should show. If lenders are also looking to make some profit along the way, then you should show them the returns they are getting.
There is no reason for you to reconcile the information presented to lenders and borrowers unless your stakeholders (bystanders are not your stakeholder) demand the information.
I really like how Lending Club as a for-profit peer to peer lending platform has managed both borrowers and lenders expectations. They are a good role model to follow.
Keep up the good work.
I haven't been through the loan process on the site, but I cannot imagine that the exact terms and fees are not fully disclosed on a site like this. I just don't see anything wrong here given that the site deals in loans with many variables. At worst they are guilty of advertising a number that does not have a lot of meaning to borrowers, but again they have two sets of constituents: borrowers and lenders. This number does have meaning to lenders.
I'm not saying that is unusual, for a lender. Financial products always come with a lot of smallprint, with actual important things hidden amongst it.
But aren't you supposed to be disrupting this industry? Being different? Isn't this a great opportunity to do it?
You have a whole bunch of fees and rates. Presumably, you do things this way to incentivize good borrowing behavior, and present the loan as cheap to compete with people doing the same.
How about rolling all these fees and rates into a single fee and a single interest rate? Why charge new customers extra? The simpler the terms, the more rational a decision the user can make. If the user knows they can afford it, your chance of defaults is lower...
That said this looks like an awesome response. I think you're net good, but I know what happens down the revolving credit pothole, if you're helping people avoid that its fantastic.
One other concern, your fee structure and business model seem to encourage repeat loans, how do you avoid the situation where that goes horribly wrong?
We do our best to ensure loans do not cause over-indebtedness by starting with very small amounts initially, and increasing credit limits only if high on-time repayment rates are maintained over time. In order to minimize the risk of borrowers taking out local loans in order to repay Zidisha loans, we do not allow credit limit increases if a large percentage of Zidisha loans are repaid in a short period of time.
In my experience, repeat loans have been a vehicle for increasing assets and revenue over time, not for increasing indebtedness. Here are a few among many examples:
Brilliantly, breathtakingly cynical! Charge a bunch of flat up-front fees, then cap loan amounts based on some opaque criteria.
Thanks for noticing that. I am not finding the quote "And that's just for repeat borrowers (by sheer chance, none of the 20 random loans was from a first-time borrower)." in the blog post now.
I did take a look at the borrower profiles that were linked below the photo collage, and the majority of them were indeed first-time loans. These can be identified in that only second and subsequent loans include the link "View previous loans" below the on-time repayment rate displayed in the profile pages.
I'll go back and look at the 20 loans with your tip in mind, and recalculate APRs separately for both first-time borrowers and repeat borrowers, and update the post.
I see what you mean. This is confusing because our website is programmed to display the registration fee only for applicants who have not yet had a loan disbursed. Once a loan is disbursed, the fee is paid and is no longer displayed in the loan profile page as part of the amount due to be paid by the borrower.
The second and subsequent loans contain a link "View previous loans" under the "On-Time Repayments" record in the right panel. All the loans that do not have that link are first loans.
You don't understand eBay.
Maybe when eBay was the wild west new sellers would offer a discount. This just doesn't happen anymore and not in many years. Why would they? The buyers know they are protected by eBay's buyer protection program so buying from eBay is very safe, it is safer than selling on eBay. Sellers need insurance on what they sell (or they self insure) because a buyer can claim they didn't get the package or it was damaged and eBay will always side with the buyer and burn the seller. This is a fairly well known scam. Feedback is almost completely meaningless anyway. I've been burned by eBay sellers who had 50,000 feedback. They sent me a beat up broken case DVD with possible water damaged when it was supposed to be brand new. When I complained to them they wanted me to either 1)ship it back at my expense or 2)keep it with a 30% refund. Neither are acceptable in eBay's eyes, so I opened up a dispute and got my money back the next day. I also bought mislabeled batteries that were advertised as a different (reputable) brand on eBay from a scam seller with thousands of feedback. The second I complained the seller refunded me. eBay is very clear on their buyer protections. So sellers would be cutting into their profit margins for what? Selling on eBay is already fairly expensive, there is lots of fees. Quite a few sellers don't make it a business, I know I just use eBay once in a while to get rid of some stuff I would get rid of anyway, so just trying to get a few bucks off of something I would otherwise get $0 for. If every seller who used eBay that way had to sell their stuff at a discount, it wouldn't be appealing to the sometimes-sellers.
If I saw a new seller with discounted merchandise, it would look shady, I would think it might be possibly stolen.
Don't compare it to something that doesn't exist.
>6. We use flat rates not in order to deceive, but simply because they are more intuitive to borrowers and lenders than APR.
So how come the US outlawed them with the Truth in Lending Act? Because they wanted to bring transparency to lending. Flat rates hide the true cost.
Edited to add:
>Zidisha has lowered the interest rate to borrowers throughout Africa and other developing nations to under 10 percent. There is also a 5 percent service fee, which covers messaging costs and and transfer fees.
Africa isn't a country, stop treating it like one.
That said, these rates are no worse (and in many cases better) than other Microloan program. It highlights the dearth of credit for good projects when people can make a profit borrowing at such high rates.
This is a highly lucrative business.
Zidisha's total revenue and operating costs are less than $10K per month. Only two people, myself and a web developer, receive a salary for working with Zidisha. (That salary is barely enough to cover the cost of a shared or low-income apartment.) Everyone else who works with Zidisha is an unpaid volunteer.
That is, are people really paying the registration fee once and then taking out multiple loans, or are most of your borrowers first-time borrowers?
As of today, we've funded 5812 loans and have 4757 registered borrowers, so the majority of loans we've funded have been first loans. That said, we have almost no registered borrowers without loans. We don't have precise data but I would estimate over 95% of borrowers go on to raise additional loans after their first is repaid.
The reason for the high proportion of first loans is that our growth has accelerated in the past several months, and most of this growth has been a result of admitting new borrowers. We expect the large majority of these new borrowers will go on to raise multiple loans, as has historically been the case.
I hadn't considered the cultural differences of the target audience. This would be dishonest for a US market, but I understand it here.
I don't know about this line of reasoning. If, as appears to be the case, flat rates were designed to mislead borrowers into thinking they were getting lower rates, then engaging in that practice doesn't seem to be any more just, simply because others in the market are doing it. APRs were mandated in the U.S. for a reason.
I get that they need to show competitive rates, which means showing APR vs. competitors' flat interest wouldn't work without additional explanation. However, there are fairly easy ways to educate their market and do so in a way that differentiates themselves even further, especially if their pricing is really significantly better.
For instance, if I were a potential client, I would greatly appreciate a quick lesson on APR, and a comparison to competitive programs that re-expresses their rates in terms of APR. You'd earn good will for transparency/benevolence and my business for the better rates.
The flat rate is horribly misleading if you are comparing the flat rate for a fixed period of loans with different repayment periods, which might be the case if relying on advertised rates intended to mislead. It's fine, on the other hand, if the potential borrower goes to lender A and B and requests a quote for a specific loan period.
But I agree with you that a quick lesson on APR and showing APR also would be great.
But there is a likelihood that not everybody understands it. Journalists and bloggers just throw out the 5% figure without specifying what it means because it makes for a nice sounding blurb.
Zidisha is surely marketing themselves to lenders on the basis that they offer a good rate to borrowers, that's supposed to be a motivation to lenders to participate.
Interestingly the Wikipedia page figures seem [at a glance] to say that in some countries less than 50% of loans are even repaid.
A few years ago Australian politicians started targeting 'payday loans' and other "predatory lenders." The upshot was that these weasels target vulnerable borrowers with 100%+ APR loans, who are ultimately harmed. 'Vulnerable' is hard to define or measure. Harm is virtually impossible. 'Predatory terms' (interest rates) were the only easy of defining and singling out these guys. Legally it seems to have been hard to target predatory lending so name-and-shame was the main tactic .
A typical loan is a few hundred dollars payable in a few weeks. The ideal borrower goes down a revolving credit hole. For a class-minded political activist this screams evil. It's like the middle class debt trap, beefed up and tailored for the poor and/or dysfunctional. The marketing targets addicts, gamblers, welfare recipients, etc. The whole thing stinks to high heaven.
The first thing that happened when all this negative attention came about is that banks got out of anything even similar to payday loans. No point in tarnishing their brand for a tiny unattractive business. The guys who stayed in business were the scummiest, the ones who didn't care about brand and didn't care about their business. It became like running a brothel, legal but unsavory. The industry boomed as more legitimate businesses ceded market share to the shadier players.
Realistically, there are two facts that can't be wished away. High risk, low value loans are expensive to provide. People want/need payday loans and they will get them from whoever is giving them. It can't be done at non "predatory" APRs and it can't be shut down. If they had outright outlawed payday loans, then shady businesses would have given way to outright criminals, the leg breaking loanshark cliche.
In comes micro-finance. Nobel peace prize winning, poverty alleviating, enlightened, woman emancipating microfinance. These ran with a lot of support. They attracted great people at far under-market salaries. Motivated employees with a mission and received outright donations from the public. Major banks created microfinance programs as a part of their corporate responsibility, goodwill project.
These amount to a real and substantial summary. Annualized interest rates are still very high. Lower than payday loans and much lower than village lenders and loan sharks they displace but higher than the worst credit card.
Two ends of the spectrum. One on the border region of legality below the decent folk morality threshold. The other, literally a charitable activity.
Interesting to think about. Make something illegal and it runs as a criminal enterprise. Treat it as a predatory pariah and it behaves like a predatory pariah. Treat it as a charitable act, and it behaves that way. In no case does it go away.
I think the article makes a case for the first, but we shouldn't immediately conclude that means that on-average-very-high-interest microloans are somehow intrinsically the subject of moral disapprobation (as I've seen suggested in at least some comments).
I think there is a (third) real question as to how to brand high-risk services like this.
EDIT: I think this top level comment (currently) below by jfasi is highly on point: https://news.ycombinator.com/item?id=7547117
As much as there are many things that it is easy to think "should" be illegal, outlawing the latter rarely works, not least because the assumed victim is likely not to want to cooperate with you, and potentially being outright hostile because they see a ban as being what is victimising them, rather than the provider of the banned service.
I don't think it's defeatist to accept this - it just means another angle is needed that the presumed victim will actually agree is beneficial to them, such as providing free financial advice, or mandating better information about actual loan costs. This is the approach taken to payday loans in the UK.
It doesn't stop the people who has a genuine need for cash even if it is expensive, doesn't drive them into the hand of hardened criminals, but hopefully helps to minimize demand. And improved labelling helps providers that can provide more competitive rates as well - at least one UK pawnbroker explicitly targets payday loan providers with their advertising by pointing to the lower rates they can provide, for example.
To an extent it's defeatist because I'm saying you can't make things cease to exist with laws. make it. But a lot of things are really like that. We can't legislate things in and out of existence. Personally, I find it quite disturbing that there are hardworking people earning a poverty wage at or near minimum wage. My common sense idea about what a minimum fair wage is about twice what it is. Doubling minimum wage in Europe (like tripling or quadrupling it in The States) will not help the people earning that wage, on average. Many of them will just end up unemployed^
This particular conclusion only applies to outlawing things like drugs, prostitution or payday loans. Products of voluntary exchange. It doesn't apply to things like rape or murder. Outlawing those helps to reduce them (but doesn't eradicate them either.
In any case, I do think some things can be done. Charitable lenders or lenders with an explicitly moral charter kept on their toes by discussion like this one can and do make a big difference.
Letting normal lenders like banks do business unharassed is preferable to hounding them, for everyone involved. Doing something just to do something even if it's harmful is madness. Control yourselves do-gooders.
^I purposely said double. Most people will agree that a very large increase minimum wage would cause unemployment. Not trying to start an argument about this.
Despite the fact the interest rates are so high, payday loans are not a very profitable business. The reason the interest rates are so high is because they are rarely paid (expectedly). Most of the payday loan companies in the US have profit margins on 6%. Compare that to legitimate banks who have 30-40% margins. Any tighter restrictions would wipe away what little margins they have.
Chances are if you did regulate them, it would be same as outlawing them. Legitimate businesses wouldn't be able to keep the lights on, leaving the entire business once again to criminals.
I'd also like to see some sources behind those number. As far as I know you just pulled them out of your ass. Around here there are many payday loan places that advertise on TV with celebrity spokespeople. If they weren't making a big profit, I don't know how they could afford it.
Here he outlines why they don't work -
The next reply goes into their cost effectiveness -
Now if you don't want to believe "some user on Reddit", take into account that those "payday loan places that advertise on TV" are also publicly traded companies. Here is EZPAY's public info at Yahoo Finance - http://finance.yahoo.com/q/ks?s=EZPW+Key+Statistics, their return was only 5.60%.
Heres where I got that 6%/30% number:
It's an interesting report, but the gist is that because of the high default risk, they couldn't get down to less than 100% APR, even with subisidies:
>>>Even on a not-for-profit basis, to make the service financially sustainable the cost of home credit would be high.
>>>With an £18 million subsidy, the APR on an average 56-week £288 loan would be 123 per cent (compared with 183 per cent commercially), bringing customer savings of £50. But to achieve a reduction to a 100 per cent APR would require a £90 million subsidy. Customer savings would increase to £72 per loan (£170 yearly on an average annual loan frequency of 2.34).
What do you mean by "the industry boomed"? The volume of loans increased?
But by industry, I mean specialised payday loan providers. The volume was increasing already.
If you make it illegal, it creates a worse problem because then people's legs get broken when they miss payments.
I don't feel charitable if I expect interest to be paid to me or my "emissaries."
Their apology (not half bad): http://www.givewell.org/about/shortcomings
Deceit in lending is not uncommon among microfinance organizations, but it's surprising to see it from a YC-backed company. I look forward to Zidisha's response, I'm sure they'll shed more light on it.
MeFi's analysis, which FWIW, notes that most of the offending activity was done under the founders' real first-names:
(Where is AirBnB's apology for violating Craigslist's TOS with the spamming from "Jessica"?)
A variable rate loan is one where interest can change. Credit cards are usually variable, so if I miss a payment your interest rate can go up or if you've been a customer for a long time and have a good history of paying on time your interest rate can go down. Mortgages with variable rates usually fix the rate for x years and then they reevaluate in x years. During the housing bubble, variable rate mortgages with were common.
I think the issue that the post brings up is that the target market for the microcredit borrowers consists of people used to flat rate loans, which is totally alien to the target market for lenders. I think the lenders will likely mentally map "flat rate" to the closest thing they are aware of, which is likely "fixed rate."
Organizations like this should not be not-for-profits. I don't believe that a business with such misrepresentation would have lasted this long without being called out. Hiding behind the not-for-profit label in markets where for-profits should be operating does nothing but distort the market and lull consumers/lenders into a false sense of do-gooding. These are financial markets and so we need to find effective market actors instead of not-for-profits that can unfairly compete due to their status.
By using the not-for-profit label and misrepresenting interest rates, Zidisha is also painting the picture (whether they intend to or not) that businesses in this space are exploitative and that Zidisha is good. Micro-loans are expensive loans! Businesses have to charge a lot for them to be economical, but access to credit for high-turnover businesses can make a huge a difference if it makes sense for the business.
What is really needed in the space isn't necessarily a lending platform, but more data and better techniques to lend. It's tough to vet entrepreneurs cheaply and at scale, but something I hope we will continue to get better at. There is a ton of money in the impact investing sector right now that could do a lot of good through market channels but lending in the developing world is still just too expensive and too risky.
I'll close with another misleading statement from the October 2012 interview that the author of the blog post didn't discuss:
... the total rate paid from the borrower’s perspective averages 8.40%. Note that this is not much above the average rate of inflation in the borrowers’ countries.
The problem here is that this statement assumes a stable currency against the US dollar. While 8.40% may be close to the inflation rate, for many of these countries an additional several percentage points of currency devaluation against the US dollar will raise the effective interest rate in local currency. I would love to understand how Zidisha deals with the challenge of currency fluctuations, especially when educating its borrowers.
I hope the takeaway from this is not that micro credit and lending in the developing world is bad and exploitative - just that it is expensive and nobody is that great at it yet. I'm disappointed in Zidisha's misrepresentation but I hope it makes it clear that this isn't a solved problem that greed and bad business practice is getting in the way of. It's an extremely difficult, unsolved problem that we need more smart people working on to solve.
If the OP is uncovering exorbitant fees, someone must be getting rich. I'd like to know what happens when you follow the money. If no one is getting rich, is that evidence of an honest service trying to make the world better for those born someplace other than the developed world?
Thanks in part to this debate, we have opted to reduce the interest Zidisha borrowers may offer to lenders. You may view the full announcement and discussion here:
30% seems to be common.
When I got my first CC I just got a low limit ($600), not high interest.
They have 2 at 30%, 6 at 35%, 1 at 40% and 1 at 60% and all of them need to approve you even at those levels, and may increase them for particularly bad risks (they market them as "representative" rates, so some percentage of people needs to get them I think).
I'd guess the people who aren't savvy enough to go through a price comparison search also get stung at the high end of these rates too.
I get bogged down in such interest rate debates, so decided to put my money where my mouth is and lend on Zidisha - MY loans, MY transactions, MY calculations. I uploaded $1000. 18 months later (in fact slightly less as I did this in two batches of $500, minor detail) my cash + pending loans + outstanding capital is $1006. For all practical purposes let's say I am at break-even. I made some money in interest, however calculated, and I lost some money in defaults, late payments and foreign exchange losses. Overall these cancelled out (in fact I am $6 up). My average interest rate that I charged, weighted by the amount I bid, was 4.4% (flat per year I believe). I had a few late payments, one outright default, and I have no idea how much forex losses cost me. To repeat, this all largely cancelled out.
I then looked at the average interest rates as stated by Zidisha only for the clients I had lent to. These were 9.31%, but included the 5% fee that Zidisha charged, so it appeared that the average investor was charging 4.31%, marginally lower than me. Indeed, I lent to a few people who were unwilling to pay any interest, and sure enough their stated rate was 5% - the Zidisha fee alone. So, in terms of Zidisha claiming the average LENDER interest rate is 5.3% seems reasonable from my personal lending experience (40 loans to date).
I agree that flat rates are inferior. I wish Zidisha would stop this practice. And it is a fair rule of thumb to double them to get a real APR. There is a fragment of truth in the claim that borrowers understand flat interest rates better than APRs, as these are still common in some countries (where they have not yet been outlawed). Claiming the world was flat a few centuries ago was acceptable and commonly accepted, although wrong! I agree with the author that converting to APRs would be better. But, I also agree that the one-off fee for a credit check, in this lending model, does seem reasonable. But I concede that this is a debatable point.
So, excluding this one-off fee, it does appear that the loans I have personally done have an APR of about 20% (9.31% x 2). What's more, by me charging 4.4% (flat, equivelent to 9% APR), this has covered forex losses and defaults over an 18 month period, almost perfectly (by coincidence). I don't lend on Zidisha to make money, but if I can protect my capital, that is fine by me. This is what most other P2Ps will try to offer. MyC4 offers a net return, Kiva is generally break-even. What fascinates me about Zidisha is that there is no intermediary, and the rates do genuinely seem lower. I accept this might not be the case for a first time client on a $50 loan having to pay $12 for the credit check. The one-off fee is the source of the problem. But where do we draw the line - what about the bus fare to get to the office? The cost of completing the forms? The opportunity cost of time in completing the Zidisha process? Yes, there are entry costs to join Zidisha, as there are in many services. Indeed, one could argue these present a barrier to entry to dissuade non-serious potential borrowers.
Do not mis-understand me, I am a fanatic for transparent pricing in microfinance.
In fact, I should also add that there is an additional fee which I (i.e. from a lender perspective) have to incur that wipes out my measly $6 profit - the PayPal fee, which was $34 in my case. So, in fact, I lost $28. But, a rate of 20%, or 25%, or 30%, is alas pretty reasonable, particularly in Africa. I agree that Zidisha should adopt APRs as soon as possible, but I would be hesitant to describe this as deceptive. There is no pre-funding, at least they make an effort to state the interest rate, which some P2Ps don't even attempt. I do hover the mouse over the blue buttoms and was aware that this is flat, and I know how to interpret this, but I may not be typical. But compare this to Kiva, whose greatest effort to explain an interest rate is to state the self-reported, unverified portfolio yield of the bank as copied from the MixMarket often years out of date, and this is not even a good proxy of the APR in my opinion. I did a blog post a year or so ago comparing the stated portfolio yields reported by Kiva compared to the actual APRs calculated by Chuck Waterfield, and the divergence is staggering. Is Zidisha perfect, no? Is it an interesting development, challenging the status quo of the current P2P market? In my opinion, yes. There is scope for improvement, and I hope they constantly remain aware of this, but so far I find this a promising venture. It will be interesting to see how it scales up.
Hugh Sinclair, author/consultant
They might have all the legitimate reasons in the world to want to use the flat rate. But none of them detract from the fact that the rest of the industry uses one metric to describe their products, and they come in and use a different metric that's easy to confuse with the usual one and looks a ton better.
That lies somewhere between not very transparent and outright scummy.
At the small scale, those fees have to be paid by the borrower, making APR a poor metric.