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Fintech startups are increasingly leaning into lending for the more than one-third of Americans with subprime credit scores. Their vision is to turn a negative connotation into one that not only helps short-term borrowers, but builds their credit and provides financial education.

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The term 鈥渟ubprime鈥� is typically applied to a borrower with less-than-perfect credit and a FICO score of below 670, a category that fall into, according to credit bureau . (FICO is an abbreviation for the, the first company to offer a credit-risk model with a score.)

People in this category tend to have few borrowing options other than a subprime lender, which can lead to a cycle of debt, according to , co-founder and CEO at financial app.

鈥淭he problem at large is there are no alternatives to payday loans,鈥� Sanchez told 附近上门 News. 鈥淥verdraft fees are also a huge problem. Even during the pandemic, banks were charging overdraft fees knowing that people lost their jobs.鈥�

In 2019, about 37 percent of Americans reported they didn鈥檛 have enough to cover a $400 emergency expense, .

And when they get into an emergency, there are not many places for people to receive loan help, according to , professor and Frederick M. Hart Chair in Consumer and Clinical Law at the .

鈥淪tudies have found that people don鈥檛 shop around, mainly because of the desperation involved and the fact that there is not much difference in the pricing of the payday loans,鈥� Martin said in an interview.

She sees two problems with the current loans: Lending fees are often high compared to the loan 鈥� think a $50 fee for a $100 loan 鈥� and people often get caught in a 鈥渄ebt trap鈥� where they keep paying those fees and never actually pay off the principal of the loan, resulting in paying much more than was originally borrowed.

Borrowers desperate for cash often don鈥檛 look closely at the cost of the loan when they鈥檙e seeking a lifeline, she said, only to realize as they鈥檙e paying it off how expensive it truly is.

Investing in new methods

Since 2017, more than $94 billion has been invested in U.S. companies focused on financial services, per 附近上门 data. Between 2019 and 2020, there was a 29 percent boost in funding dollars, though the number of investments was down nearly 13 percent. So far in 2021, $19.5 billion has been invested into the sector.

Over the past six months, venture capital investors have funded a number of startup companies focused on alternatives to payday lending and financial literacy, including FloatMe, which in December raised a $3.7 million seed led by.

Other recent U.S. investments in the space include:

• New York-based credit card company closed on more than $126.6 million in a debt facility backed by and to expand its credit card programs for those who are new to credit and overlooked by big banks.
• San Francisco-based announced a $15 million Series A raise led by for its platform aimed at building credit, savings and financial planning.
• , also based in San Francisco, provides financial services for immigrants and raised a $100 million debt facility from to support its lending product and new checking account product for customers and people without credit.
• Los Angeles-based raised $10 million in Series A funding, led by . The company is building a new type of peer-to-peer lending group in which strangers fund strangers asking for short-term personal loans for immediate needs.

Latin America has also become a hot market for startup innovation in the consumer lending category. Mexico City-based earlier this month raised $2.5 million in a seed round led by to develop a buy now, pay later concept aimed at millions of low-income, unbanked families in Latin America for whom purchasing home appliances is difficult.

, a mobile lending platform also based in Mexico, in March closed on a $3 million growth round from Mexican financial services firm Grupo Alfin for its proprietary technology aimed at boosting financial inclusion and education. And last November, and led a $5 million seed round in Brazilian fintech startup, which is developing a financial education platform that not only offers free lectures and courses, but also salary-advance services.

Seeing the success of companies, such as , that are serving subprime borrowers has been a big driver for the investment, said , co-founder and general partner of .

鈥淚鈥檝e seen a lot of people tap into apps that help you get your money two days early, as well as more real-time access to funds to pay bills when they get them,鈥� Lynn told 附近上门 News. 鈥淵ou are not waiting for a pay cycle, there is cash-based underwriting made possible by companies like , and it is much less expensive to service users.鈥�

Lynn spent 20 years in the credit industry, experiencing multiple cycles. She cautions other investors that subprime is a dangerous category to play in and that firms should choose companies wisely based on how operations are truly running.

In 2019, Canvas in , a Seattle-based company that helps people with little to no credit history gain access to credit and improve their financial future 鈥渨ithout being predatory,鈥� Lynn wrote in her blog post.

鈥淧ossible has done well in COVID, which pressure-tested it,鈥� she added.

Swapping cash flow for credit

Sanchez himself had his own brush with payday lending: He was involved in a car accident and didn鈥檛 have a credit card, so he took out a payday loan that ended up putting him in financial hardship.

That prompted him and two co-founders to start Austin-based FloatMe in 2018 to provide interest-free and credit-free 鈥渇loats鈥� of up to $50, account monitoring to prevent overdrafts, and savings and education tools.

If more people like Sanchez, who have experienced the negative aspects of the payday loans firsthand, would come into the lending space with transparency and education, it will be good for the industry, Martin said.

鈥淲e have a chance of making it work for people,鈥� she added.

Sanchez found that when someone qualified for an advance of $200, even if a person didn鈥檛 need the entire amount, they often took it, but then found themselves in a $200 hole as interest and fees racked up. Instead, smaller amounts 鈥� think $20, $30 or $50 鈥� are easier to pay back, he said.

鈥淭he solution is proving that even a small amount can make a difference,鈥� he added. 鈥淚t could mean being able to put gas in your car or paying the minimum payment on a credit card or buying food.鈥�

Over the past three years, FloatMe has processed nearly 1 million of its small 鈥渇loats,鈥� which use cash flow underwriting as the basis for the loans versus the traditional credit score, which is not 鈥渙ne-size-fits-all,鈥� Sanchez said.

The cash flow method means the company looks at the borrower鈥檚 expenses going out the day prior to and the day after someone鈥檚 payday and what income is coming in. That method has enabled FloatMe to make good decisions and trust in a model that it can supplement credit scores, he added.

FloatMe plans to expand beyond helping consumers with their cash shortfalls, Sanchez said. The company has a budgeting feature in the works to be released at the end of May, and is exploring other income-earning opportunities for users. It may also offer credit products in the future.

鈥淭he largest expenses someone has are rent and bills, which leave a little bit of capital for the rest of the month,鈥� Sanchez said. 鈥淚t鈥檚 hard to get out of that situation. We need to be doing better as an economy to unlock earning potential and keep down the rising costs of living.鈥�

Regulatory approach

When President took office in January, one of his stated priorities included investigating payday lending, suggesting that the would under his administration.

Biden nominated , who has been vocal about , to the top job at the bureau.

The U.S.鈥� credit and lending problems will not be easy to solve, Lynn said. She鈥檚 seen different incarnations of the payday loan concept, including some that offer loans with zero interest but a subscription fee.

There should continue to be options for consumers who live paycheck to paycheck to manage and improve their finances, coupled with financial literacy education, she said.

鈥淚f all credit options were taken away, it wouldn鈥檛 allow someone to grow,鈥� Lynn said. 鈥淐ompanies also need to provide credit in a way that is transparent and ethical.鈥�

Payday lending interest rates are regulated on a state level. That means it would be difficult for the federal government to set an interest rate cap, although a federal cap would be one way to address the problem, Martin said. CFPB has for lenders, including 鈥淭he 2017 Rule,鈥� which prohibited lenders from debiting a borrower鈥檚 account under certain conditions, as well as聽 requiring lenders to determine whether borrowers could repay their loans.

Another would be giving the CFPB more power to investigate lenders.

鈥淪ome of the smaller loans may have higher interest rates and might need a higher cap, but there could also be solutions like a waiting period between loans or limitations on the number of loans someone could take out in a certain period,鈥� Martin added. 鈥淚t is also time to start thinking how one might regulate new products being offered.鈥�

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