A former Google executive has moved from the world of Internet searches to the world of high-interest, short-term lending. He says his operation, ZestCash.com, offers an innovative way to help the poorest borrowers avoid financial emergencies. But is this just a slick veneer putting a shine on the classic payday lending business?
One-time Google Chief Information Officer Douglas Merrill founded online-only lender ZestCash, which uses some fairly high-level Google-esque algorithms to assess its borrowers' creditworthiness. And the site certainly looks better than your typical payday lender. Those sketchy outfits usually operate out of rundown storefronts in lower-income neighborhoods, offering quick cash infusions at jacked-up interest rates to people with nowhere else to turn.
But friendly looking ZestCash does essentially the same thing: Its loans ring up at triple-digit interest rates. For example, a three-month $800 loan will cost nearly $550 in interest and fees at the 412% interest rate that ZestCash charges.
The site is one of a number of new businesses popping up to cater to a growing segment of Americans: The poor and credit-challenged who don't -- or can't -- use a bank. As high unemployment and falling wages continue to push more Americans into poverty, financial innovators like Merrill are on the lookout for new ways to milk profits out of this demographic.
Firmly on the 'Loan Shark' End of the Spectrum
Merrill says that his new model for assessing a borrower's creditworthiness and setting installment payments means he can offer lower rates than standard payday operators. But when one is talking in either case about interest rates of more than 400%, the degree of difference is arguably meaningless. The Center for Responsible Lending, a national policy advisory nonprofit for lending issues, defines any operation charging more than 36% interest -- a rate cap that 17 states have put in place -- as a loan shark, regardless of the secret formula it uses to underwrite its high-risk loans.
ZestCash says its rates are up to 50% lower than other payday lenders -- but some of that nuance is hard to calculate, and depends the ability of the borrower to repay the loan on its due date. If you can't make the weekly $101 payment, add a $35 ZestCast late fee to your balance. If the payment bounces, that's $35 plus a possible overdraft fee of up to $35 from your bank. And if you can't pay $101 this week, what are the chances you'll be able to afford $237 next week?
This is hardly better than online quick-cash lender, Checkngo.com, which offers a 14-day payday loan for $800 in the state of Utah, with a $200 fee, for a total of $1,000 due after two weeks. But if you can't repay the money then and have to roll over the loan, an annual interest rate of more than 650% kicks in. Multiply that by six payday periods -- or the equivalent of three months (and there is no maximum term length in Utah) -- and that $800 could cost at least $1,789.63 on the principal alone, not including interest on the $200 fee or other rollover fees. Checkngo.com did not respond to a call for comment.
Currently ZestCash is available to residents in Missouri, Utah, Idaho and South Dakota, which do not have maximum interest rates for payday loans. Four more states will be added to the roster soon, the company said.
Your Profile Includes Everything They Can Glean (and That's Plenty)
Using a formula similar to the one Google uses to rate the quality of a website, ZestCash determines a borrower's credit worthiness based on thousands of factors from cell phone behavior to an in-person interview to your Internet trail. ("Almost everyone has one," Merrill says.) They don't use a more traditional credit scoring mechanism, like a FICO score, because it is too narrow -- and if you're getting a quick loan, chances are your credit score doesn't really mean much.
But, for example, a phone number coupled with third-party data can say more about a borrower than bankruptcy, says Merrill. Using related data points -- such as how often a borrower switched phone providers, the frequency of switching, the type of provider -- and in addition to other variables plus some fancy math, ZestCash says it can determine more accurately whether a borrower is a good loan risk.
"Many of the [people without bank accounts] have prepaid cell phones," Merrill says, explaining that continuity of month-to-month plans are a good signifier of baseline financial stability. "Not having a cell phone is a negative signal because it signals that you don't even care enough to have connectivity."
Mathematically Strong, Ethically Shaky
Care enough? Or can't afford it? It's the use of factors like that one that has some critics say saying these kind of underwriting formulas are akin to economic profiling.
"What if there was a correlation between eating at McDonald's and not paying back debt?" asks Deborah Thorne, a professor at Ohio University who specializes in debt and bankruptcy issues. One of the problems with tying cell phone patterns, for example, to credit worthiness is that it unfairly targets the poorest as a justification to charge exorbitant rates, she says. In other words, super-strength math can quickly turn into fuzzy ethics.
Merrill argues the industry charges sky-high interest rates to compensate for its average 44% default rate, and that his company's default rate is already lower than that, though he didn't specify a percentage.
Using a borrower's data trail to gauge creditworthiness breaks new ground in the evolving realm of privacy. Increasingly, transaction data is being used by third-party clients to direct targeted ads. Harvesting transactional information -- like cell phone behavior -- to predict repayment odds could be the next frontier for evaluating borrowers with otherwise spotty financial pasts.
Dartmouth economist Jonathan Zinman suggests it's often not APR or how their credit risk is evaluated that is as important for consumers, but rather the economic outcome of the loan. "Is it an investment? Are borrowers taking this loan to prevent job loss or income loss?"
Catherine New can be reached at firstname.lastname@example.org.