A few years ago, Princeton PhD and Google CIO Douglas Merrill was enjoying some time by his pool when he received a phone call. The phone call was from his sister-in-law Vicki who was a single mom of 3, balancing full-time work and school. Vicki had called in a bind unable to afford new tires for her car. The expense was unanticipated and without new tires she would not have been able to get to work. Merrill lent her the money and asked what she would have done if it weren’t for him. Vicki responded that she would have got a payday loan. This one event led to the creation of an idea that would forever change Merrill’s career path.
Merrill considered it unfair that people with sub prime credit, who don’t have financially supportive relatives, have to resort to overpriced payday or pawn shop loans. Merrill gives the stats:
“According to the National Federation for Credit Counselors, 64% of Americans do not have a savings account of $1,000 or more to cover emergency expenses. About 17% are… able to borrow money from a family member. Unfortunately, that leaves the majority of Americans with no family to turn to, and no access to traditional credit. Unexpected expenses can push them over the edge of financial stability.”
Approximately 30 million Americans take out at least 1 payday or pawn shop loan each year to help cover unexpected expenses. These loans are essentially predatory debt, often with interest rates of over 600% hurting borrowers’ chances of regaining financial stability. Indeed payday loan payments are fee based resulting in a large number of payments that aren’t applied to the principal. In 2011 payday loan borrowers paid over $8 billion in fees.
Merrill saw a gap in the market to offer a form of credit with rates somewhere in between credit cards and payday loans. He created ZestCash (now ZestFinance) in 2010 to offer an alternative solution to payday and pawn shop loans for Americans who don’t qualify for credit cards, but may still be reliable borrowers if the traditional FICO credit assessment formula is rethought.
Merrill teamed up with Shawn Budde a senior executive for Capital One who was experienced in traditional underwriting. Together they set out to use big data to give what Merrill refers to as the “underbanked” access to lower cost credit, potentially saving this group billions of dollars in the long run.
Traditionally underwriting has utilized between 10-15 variables through logistic algorithms and or decision trees to decide whether or not to offer credit. By using big data, advanced mathematics and machine learning, ZestFinance goes beyond the traditional under writing approach, by analyzing thousands of potential credit variables (previously not examined) to assess fraud potential, default risk and long-term customer relationship potential. One previously unexamined variable which ZestFinance analyzes to determine willingness to pay, regards pre paid cell phones (popular among those with sub prime credit). A person’s willingness to keep their pre-paid phone number active, can correlate with the likelihood they will make payments on their loan.
Today ZestFinance offer loans of $300 to $800 through Spotloan for rates approximately 50% less than standard payday loans. Unlike payday loans every payment made by the borrower reduces the principal as well as paying down the interest.
ZestFinance hope to bring the “underbanked” back into the financial mainstream. Merrill argues that if they can get just 10% of payday loan customers to qualify for ZestFinance loans, they will help save that group of money conscious customers $800 million. The loans are not cheap, but are a more affordable alternative for those that don’t qualify for traditional credit or don’t have relatives to borrow funds from.
To learn more about Douglas Merrill’s “big idea” watch his TedX presentation below: