Improving The Payday Loan

Silicon valley startups, such as ZestFinance, founded by the former chief information officer at Google, Douglas Merrill, are starting to tackle the challenge of "subprime" borrowers. Marcus Wohlsen explains how finely tuned algorithms could be key to lowering the high rates often charged to them:

In theory, the high cost of a traditional payday loan stems from the greater risk a lender takes advancing cash to someone who can’t qualify for other forms of credit. Some critics contend payday lenders charge usurious rates to trap borrowers in a cycle of debt they can’t escape. But even lenders acting in good faith can’t offer the low rates made possible by ZestFinance’s algorithms, Merrill says.

Using data-crunching skills polished at Google, Merrill says ZestFinance analyzes 70,000 variables to create a finely tuned risk profile of every borrower that goes far beyond the bounds of traditional credit scoring. The more accurately a lender can assess a borrower’s risk of default, the more accurately a lender can price a loan. Just going by a person’s income minus expenses, the calculus most often used to determine credit-worthiness, is hardly enough to predict whether a person will pay back a loan, he says.

"Our finding, much like in Google search quality, is that there’s actually hundreds of small signals, if you know where to find them," Merrill says. For instance, he says, many subprime borrowers also use prepaid cellphones. If they let the account lapse, they lose their phone number. Would-be borrowers who don’t make keeping a consistent phone number a priority send a “huge negative signal.” It’s not about ability to pay, he says. It’s about willingness to pay.