Is Loaning Money at a 350% APR Evil?

03/29/12

In the early part of this year, a new start-up called ZestCash launched. Founded by former Google CIO, Douglas Merrill, it appears to be an attempt at short-term consumer lending with a Google-like "don't be evil" approach and markets itself as an alternative to payday loans.The venture caught my eye when mentioned in the New York Times this weekend as part of a story about Gil Ebaz's work of adding value to different services by providing better, more reliable data.

ZestCash intends to use different information and algorithms to assess the likelihood of repayment. The New York Times story suggests that this information will include cell phone bills. As someone who works a lot with data, I have little doubt that there is a lot of information that will do a better job of predicting repayment than the information currently in credit reports. Better accuracy should translate into lower interest rates for consumers. If there is transmission of consumer information from an unrelated company to another, as a lawyer I wonder whether this can all be done without becoming a credit reporting agency and triggering regulation under the Fair Credit Reporting Act. But, I presume (or at least hope) ZestCash has lawyers advising it on those FCRA isssues.

Here is the catch, ZestCash's own web site discloses that its maximum rates may have up to a 350% APR. There has been laudatory and not-so-laudatory coverage of ZestCash. As a friend of mine was fond of saying, personally I feel strongly both ways. Demand for short-term consumer loans is not going to go way. High-priced and abusive consumer lending needs solutions, and we should not discourage market-based experiments to provide better short-term loans. ZestCash does eliminate the abusive rollover feature of payday loans. Also, its bounced-check fee of $10 also strikes me as reasonable. ZestCash's web site even directs potential customers to legitimate web sites that help people deal with debt such as the Consumer Federation of America or the Center for Financial Services Innovation.

But, 350% APR . . . wow. Credit unions are offering products similar to payday loans at interest rates under 36%. To be fair to ZestCash, the 350% APR is the maximum rate. It would be useful to know at what actual rates ZestCash's lending is occurring, but the disclosures on its web site suggest rates much higher than what many credit unions offers for a similar product. ZestCash claims to have better predictive models on repayment, but such a high APR would still be suggestive of high default rates. Maybe it is fixed costs that just translate into a high APR, but even considering the fixed costs of a short-term loan, amortizing them over a two- to six-month should not yield such APRs approaching 350%.We need solutions to high-priced consumer lending, but those solutions are not more high-priced consumer lending.

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