Posts Tagged default rate

Many of our colleagues have brought up great points and questions regarding YadYap and the payday loan industry in general. While we are not ready to divulge all the details behind YadYap, we hope this post will help clarify some important points.

Let’s start with a macro look at the payday loan industry. The payday loan industry is large; according to industry estimates over $45 billion in loans are issued annually with roughly 8% of these loans taking place online.  These loans generate over $8.5 billion of fee income. These statistics are telling of the demand and need for short term loans.

The name of the game from the lenders perspective is risk adjusted returns. In today’s market, if a lender wants to invest in payday loans his / her only option is to invest in an actual cash advance / payday loan store or an online payday lender. We know of investors that are compensated as high as 3% per month on their invested capital.  Yes, that is 36% annually and the stores still stay in business and make profits for themselves after factoring in default rates and paying investors.  In fact many communities throughout the US have placed moratoriums on the number of payday loan stores that can be in a given geographic area due to over building. An article in the NY Times, that Weiwen Ng referred to in a post, stated there are more check cashing, cash advance and payday loan stores in the US than both McDonald’s and Starbucks combined.

There is room to make the process more efficient by allowing investors to lend directly through an innovative technology driven platform that helps manage default risk and incentivizes borrowers. We believe our system will enable investors to make attractive social and monetary returns on their money while benefiting borrowers with lower costs of capital.  Eventually cheaper, longer term loans will be available that will allow borrowers to break the debt cycle.

When talking about “fair returns” or “fair interest rates” the kicker is definitely in the default rate. Industry rates remain high due to the number of defaults payday loans produce.  We believe that in today’s payday loan market the borrower is often times not adequately represented.  By helping the borrower first meet their short-term liquidity needs, then educating them and enabling them to attract cheaper capital and eventually helping them qualify for cheaper longer term loans borrowers will see the value in using YadYap.

The current cycle of borrowing, paying off the loan and borrowing again is not helping anyone solve their long-term liquidity needs. Many payday borrowers get multiple payday loans throughout a year, often as many as five or more per year. While we are not encouraging this, it shows that these borrowers generally pay back their loans only to take out another loan a short time later and get caught in a debt trap without options.  YadYap plans to change this by enabling, recognizing, and rewarding positive performance to create a clear path to end the debt cycle.

In today’s market, subprime borrowers need short term capital in a significant way. The volumes of payday loans generally increase during times of economic contraction. On the flip side, defaults generally increase as well which compounds the liquidity problem. With subprime loans being one of the primary drivers of the dislocation in the credit markets, these borrowers are experiencing a severe tightening in credit options.

State governments have begun stepping in by setting caps on loan fees. There has been talk that Obama may attempt to implement a 36% rate cap for all consumer loans in the US.  If “pop a cap economics” (Thanks for the new terminology Peer Lend) go into effect this will significantly alter the $45 billion loan industry. This would likely cause more physical store fronts to close and drive more loan volumes to the Internet through offshore lending companies. There is no question, with over $45 billion of demand it will go somewhere. Offshore lenders generally charge fees in excess of $25 per $100 lent a significant increase from most current retail locations. Credit Unions and to a lesser extent banks are starting to make some inroads but are faced with challenges of servicing this niche in a profitable way.

At YadYap we are dedicated and focused on innovation and the P2P model by using technology to deliver a platform that will better the lives of many. We stay well informed on current laws and potential changes that could impact the industry. We will play within the legal bounds but caps will naturally limit the number of people who will have credit options. YadYap will put its money where its mouth is by participating as a lender to prove out this new model. Ruling out socialism or free money, the best model will allow competition, borrower representation and profits to lenders for risk taken.