Analysis

Payday lender’s pros and cons on reporting data to credit bureaus

LoanNow is focusing on creating opportunities for deep subprime customers (low 500 FICO) by being a responsible lender and not rolling over any loans (instead, it creates an instalment for repayment for delinquents) and secondly inspiring the borrower to repay on time through its proprietary motivation algorithm. It has added another tool for motivating borrowers by reporting all credit activities to TransUnion, the third largest credit bureau in America.

LoanNow is an online marketplace lender looking to upend the payday loan industry. The Orange-County based start-up has raised over 50 million dollars in debt financing from unnamed institutional investors. The company hopes to originate 100 million dollars of debt in 2016 and also aims to reshape the payday loan industry. The industry is plagued with an extremely bad reputation of preying on its customers who usually have a FICO score of less than 650 and have damaged credit. Pay day loans are considered as a vicious circle by personal finance experts and though they are advertised as a one-time solution for a cash emergency, a typical payday borrower borrows between 5-9 times a year. The most vexing issue is the rollover which increases the debt by substantially adding up late fees and penalties on the amount due.

Credit Bureaus and Payday

Credit Bureaus play an incredibly important role in creating a financial history of the borrower by maintaining credit files which are the basis of FICO score. What goes in the credit file is extremely important as it helps create a standardized history which is the basis of consumer finance lending across America. Nowadays payday lenders do not report to any of the three major credit bureaus. At the outset, it might look to be a good deal for the borrowers as they are at a payday lender precisely because they have a low FICO score and could not afford a credit card or personal loan from their bank. But on closer scrutiny you will see that it’s a catch-22 proposition for the customer.

In a traditional financing arrangement, if you pay off your loan on a regular basis, you are rewarded as your FICO improves and you are eligible for lower APRs. But as payday lenders do not report the repayments, the borrower does not get the benefit and is still stuck because they only have access to the astronomical rates of payday lenders. If the borrower is unable to repay and the lender offloads the loan to a collection agency, the collection agency usually reports the delinquency to the credit bureaus thus creating a long term negative mark on your credit file.  Thus, you do not receive any benefit of paying on time, but non-repayment is penalized heavily.

Changing the paradigm

LoanNow is trying to change the paradigm by motivating good borrowers that the promised land of lower interest rates with longer tenures lies ahead of them if they repay on time. The company in a press release on February 17, announced its partnership with TransUnion, wherein it would report all loan performance to the credit bureau. “ By sharing loan repayment history with TransUnion, LoanNow is  helping borrowers with damaged or poor credit histories get the credit they deserve for successfully repaying a loan,” said cofounder Miron Lulic in the release.

In an interview with Lending-Times.com, officials of LoanNow explained that credit bureaus have a very thorough vetting process for lenders to be allowed to report on the credit files of the customer. Very few sub-prime lenders are allowed to report and this will be a powerful differentiator for the company as it should attract good borrowers who are looking to repay on time and move up the credit ladder.

The reasons that credit bureaus were not reporting the payday loan numbers is myriad, ranging from distrust of payday data to payday lenders themselves not focused on providing data as they have a perverse incentive to not report the repayments of the good borrowers as they would be able to move to cheaper options. They indirectly report delinquents when their debt is sold to collection agencies and thus have created a win-win situation for themselves.

The way forward

time to recover

The table above indicates the time taken for a FICO score to recover in different situations. For a borrower with a 720 score, it would take him 2.5 years to recover from just a 30-day delay in paying the mortgage. Whereas for a borrower with a 680 score, the transgression would only take 9 months to recover.

Using a credit card judiciously, increasing your credit limit and getting authorized on a card all helps to improve credit scores. But repaying on time is the most important component as it accounts for 35% of the FICO score. This showcases how important it is to reward good behavior and LoanNow has taken a great step in motivating its borrowers to be regular in repayments.

The carrot and stick system should help LoanNow target a better profile of borrowers. It would also ultimately push the entire payday loan industry to be more responsible or it would be stuck with only borrowers who do not care about credit reporting as they were not looking to repay the loan anyway.

About the author

George Popescu

Serial entrepreneur.

George sold and exited his most successful company, Boston Technologies (BT) group, in 2014. BT was a technology, market maker, high-frequency trading and inter-broker broker-dealer in the FX Spot, precious metals and CFDs space company. George was the Founder and CEO and he boot-strapped from $0 to a $20+ million in revenue without any equity investment. BT has been #1 fastest growing company in Boston in 2011 according to the Boston Business Journal and the only company being in top 10 fastest in 2012-13 as it was #5 in 2012. BT has been on the Inc. 500/5000 list of fastest growing companies in the US for 4 years in a row ( #143, #373, #897 and #1270). After the company sale in July 2014 until February 2015 George was Head-of-Strategy for Currency Mountain ( www.currencymountain.com ), a USD 100 million+ holding company focused on retail and medium institutional currencies, precious metals, stocks, fixed income and commodities businesses.

• Over the last 10 years, George founded 10 companies in online lending, craft beer brewery, exotic sports car rental space, hedge funds, peer-reviewed scientific journal ( Journal of Cellular and Molecular medicine…) and more. George advised 30+ early stage start-ups in different fields. George was also a mentor at MIT’s Venture Mentoring Services and Techstar Fintech in NY.

• Previously George obtained 3 Master's Degrees: a Master's of Science from MIT working on 3D printing, a Master’s in Electrical Engineering and Computer Science from Supelec, France and a Master's in Nanosciences from Paris XI University. Previously he worked as a visiting scientist at MIT in Bio-engineering for 2 years. George had 3 undergrad majors: Maths, Physics and Chemistry. His scientific career led to about 10 publications and patents.

• On the business side, Boston Business Journal has named me in the top 40 under 40 in 2012 in recognition of his business achievements.

• George is originally from Romania and grew up in Paris, France.

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