Investing in Online Consumer Lending

Marshall H. Dean J.D., MBA

There is a belief that payday loans gouge the customer and are not fair. But if you take time to understand it, you can start to appreciate the financial product niche that it fills.

Go ahead and get it out there. There is a belief that payday loans gouge the customer and are not fair. It is okay to think that, but if you take time to understand the small dollar unsecured loan, aka payday loan, you can start to appreciate the financial product niche that it fills. You should understand it because there are some incredible investment opportunities to fund the loans.

The first key transition to understand is that the payday loan business has mostly migrated from brick and mortar to the internet. It’s safer, easier and more convenient. As a result, internet lending businesses have been created to serve these customers. These businesses seek investors to help fund a loan portfolio.

The most common investment vehicle into the payday loan space is through a private investment limited partnership. The investment partnership will fund a portfolio of loans, and as an investor you will own a small piece of hundreds if not thousands of loans. As an investor in one of these partnerships, you can receive as much as a 15% to 20% annual return in addition to a return of your capital over a two- to three-year period.

Let’s talk about three key positives of the payday loan financial product:

1. Serves the underbanked

Many banks have looked at offering a payday advance loan product, with some even trying pilot programs. For whatever reason, the product has never had much traction with banks. There is a large demand for the small dollar loan, but no traditional sources of credit offer it as a product to customers.

2. Well-informed, protected customers

Studies show that customers understand the cost of the service because fees are clearly stated in a simple format. Loan providers set loan limits based on a customer’s net monthly income, and will not loan more to them than they should be able to reasonably pay back.

In addition, customers are allowed a limited number of rollovers (no more than four) before they must establish a payment plan. The industry has adopted an Extended Pay Plan for customers to limit their fee exposure when repaying a loan. The plan is no charge to the customer and helps to outline a payback strategy.

3. The least expensive alternative

When faced with being a few hundred dollars short that month, a customer must choose between taking out a payday loan, bouncing a check or incurring late bill payment penalties. These “late” fees can often far exceed the cost of a payday loan.

It is also important to take note of the three biggest myths to the payday industry:

1. Loans are expensive with high interest rates

The standard fee in the payday industry is a charge of $15 dollars for every $100 dollars borrowed. When you factor in the cost of the leads, overhead to run the business and the bad debt inherent in this type of financial product, only the best operators are successful.

2. Target minorities and prey on poor people

A typical borrower is a hardworking American who does not have any savings to handle the unexpected expense. Demographic studies of the typical payday customer indicate that he/she is under 45, graduated from high school and has some college credit. He/she makes between $25,000 and $50,000 per year, has a major credit card, and maintains a steady income and active checking account.

3. Perpetuates the cycle of debt

Over 70% of Americans live paycheck to paycheck with no cash reserve. When evaluating the benefit to a payday loan, customers first look to credit at a bank (normally non-existent), then to their credit card, before going down the payday loan road.

The payday loan is merely a tool to access credit. The more choices a customer has, the better. People like to have options. For those who have never been in a cash crunch similar to what these customers feel, it is not fair to judge what should and shouldn’t be available.

Misunderstood industry

Those who badmouth the payday loan business simply do not understand it. They don’t understand the niche that it fills or the people that are served, and they don’t want to.

One of a bank’s primary purposes is to loan money. Banks don’t offer credit to a payday loan customer because of the heavy regulatory burden and the small size of the loan. They can’t make any money.

The U.S. has 50 million non-bankable consumers, and there are 30 million regular uses of short-term lending options. You should consider being a part of the solution by investing in a vehicle that provides money to these hardworking people.

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Marshall H. Dean J.D./MBA is a registered representative at Alliance Affiliated Equities Corporation, a FINRA-registered broker/dealer specializing in the evaluation and acquisition of alternative investments. He invites questions and comments at (913) 428-8278 or marsh@aaeconline.com.