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Can Silicon Valley remake the payday lending industry?

Venture capital is investing heavily in tech alternatives to the payday loan industry. But is what companies like Earnin offer really any better?

Like most millennials deep in debt, I don’t spend money on luxuries like cable TV. Instead, my phone is filled with a variety of free streaming apps to cast shows, many of which use ads. One such ad, for an app called Earnin, caught my attention because it seemed to be everywhere. 

Earnin is hard to define; while it isn’t a payday lender, it provides “on-demand pay,” allowing users to access earned wages with no fees and no interest, instead prompting them to just “tip what you think is fair.” 

The ads I kept seeing featured a diverse cast of 20- or 30-somethings who find themselves in a bind. Maybe it’s a parent’s birthday and they’re too broke to buy the gift they deserve, or their gutters have fallen and they can’t get them back up. Whatever it is, ready relief is presented as just around the corner with Earnin. 

I quickly realised I wasn't the only one who felt haunted by these Earnin ads. From social media comments to full-on YouTube video rants, people seem to dislike them intensely. 

I grew up in Alief, a suburb of Houston, where cash-advance storefronts offering payday loans were littered up and down the main street, continuing to proliferate as the neighbourhood’s median income crept downward. The people queuing at those stores were not as upbeat as the actors in the Earnin ads. Texas has few regulations on payday lenders, and these brick-and-mortar payday loan stores often charged interest rates above 600 per cent. 

For many borrowers, payday lending is the last resort. Their credit-worthiness may not be up to par for mainstream bank loans, or obtaining other means of credit might take too long to address their immediate financial needs. But while this may be a fast way to get cash in hand, the repayment process can get a little trickier.

“Payday”, a 2018 episode of Netflix docuseries Dirty Money, outlines the lengths that some lenders go to deceive their customers and evade oversight. It reveals how a racing-car driver named Scott Tucker used legal exceptions carved out for Native American tribes, and deceptive agreements, to defraud consumers out of billions of dollars and dodge regulations. 

Cruelly, Tucker’s companies automatically renewed customers’ loans and applied their payments towards interest on their previous loans instead of those payments going towards paying down the principal on their payday debts, meaning most customers were actually accumulating more debt when they thought they had been paying back their loans.

Earnin is careful never to refer to itself as a payday lender – even though it boasts about being able to make any day payday. As an Earnin spokesperson made clear, “Earnin’s mission is to build a financial system that works for people . . . [our] core product, Cash Out, allows people to access the pay they’ve already earned. There are no loans, fees or hidden costs. You simply tip what you choose.”

In its white paper, Earnin claims 94 per cent of users used the app to avoid payday loans or overdraft fees. It positions itself as a clear alternative to payday loans and what the CEO has referred to as “predatory lenders with high APRs.” 

In the Netflix series, Tucker defended his company, claiming repeat customers returned because its services were “fast, simple and easy, and the company did exactly what they said they would.” On 5 January 2018, the Southern District of New York, however, decided differently, sentencing Tucker to 16 years in prison for unlawful internet payday lending on all counts against them, including racketeering, wire fraud, money laundering, and Truth-In-Lending Act (TILA) offences.

But even when payday lenders are operating lawfully, repaying loans can still be a tortuous and expensive process, leading the Obama administration to create new compliance rules, describing payday loans, along with vehicle title loans and other high-cost instalment loans, as “unfair and abusive.” In a 2013 study, “Assessing the Optimism of Payday Loan Borrowers”, Columbia University law professor Ronald Mann found most borrowers accurately predicted they would continue taking out payday loans for “some time after” their initial loan. This study would be cited in the 2014 Obama rule. 

The Consumer Financial Protection Bureau (CFPB) reported in 2014 that only 15 per cent of borrowers were actually able to repay all of their payday debts within the initial 14 days of the loan, with four out of five borrowers renewing or defaulting on a payday loan over the course of a year. Mann estimated the Obama rule would have eliminated 75 to 80 per cent of payday lenders’ customer base, by just requiring lenders to determine a borrowers’ ability to pay back their loan before giving out the said loan.

In an interview, Mann said he felt his study’s suggestions were “contrary to the impulse of [the Obama] regulation” – which aimed to regulate lenders on the basis that borrowers did not really know what they were getting themselves into. His survey showed about 60 per cent of borrowers could accurately predict how long it would take them to repay their loans. Mann asserts, the paper suggests that the consumers of payday products “for whom every penny really matters, actually understand pretty well.” Mann concedes the study only sampled a small group of borrowers from a handful of states, still, it is the only study of its kind. 

Whether or not Mann’s findings are an accurate representation of the larger community of payday borrowers, the Trump administration concurred; the CFPB reversed the regulation in June falls more in line with Mann’s interpretation. The “Payday, Vehicle Title, and Certain High-Cost Installment Loans; Delay of Compliance Date; Correcting Amendments” – which really gives it all away in the title – delayed the compliance date for mandatory underwriting and other key provisions of the rule until 19 November 2020; conveniently just after the US election cycle.

Payday industry leaders are biting at the opportunity to further weaken the chances of heavy regulations; with the Washington Post reporting on audio from a September online discussion of its strategy to use large donations to the RNC to gain leverage in the administration. Certainly, the June reversal is a big win for the payday loan industry. Nonetheless, even if they can fend off regulations or legislation in the future, fintech cash advance applications like Earnin, operating outside of our current regulatory framework, may pose a bigger threat – to the business model of traditional payday lending companies, but potentially also to consumers. 

Jim Hawkins, a law professor from the University of Houston known for researching the fringe banking industry, wrote the first legal paper analyzing tech companies in the “earned wage advance market.” Looking at these companies in terms of their relationship with regulations, as well as, the contracts they make with their customers.

Hawkins gave me a look at his research, in which he argues such “earned wage access products have the potential to end the thirty-year reign of payday lending.” He claims these companies offer an attractive alternative to payday loans while not neatly fitting into existing legal categories. Currently, these apps aren’t subject to the Truth-in-Lending Act (TILA) which requires creditors and lenders to disclose their terms and costs to borrowers. 

According to Hawkins, these terms can be onerous and “…surprisingly unfriendly to consumers given the [fintech] companies’ social mission.” He later makes a case that “policymakers should enact rules specifically tailored to earned wage advances.” The new CFPB rule does make one ambiguous caveat for direct-from-employer wage advances, but companies like Earnin offering direct-to-consumer advances and other fintech companies do not fit into this niche. 

There are a lot of models for fintech companies in the earned wage advance market. Other app-based products like Dave, Brigit, or MoneyLion charge monthly membership fees or require deposits. Fintech company Even shows similarities to Earnin, but seems to work primarily with employers directly, and charges membership fees for instant pay features.

Despite rollbacks on federal regulations, over a dozen states and the District of Columbia continue to have outright bans on payday loans, while other states use consumer protections like capping APRs at certain thresholds. Still, the Earnin app is available to any US user with a smartphone, a bank account, and the willingness to regularly share their personal and banking information with ACTIVEHOURS, INC

CFPB director Kathy Kraninger is quoted in a February statement by the Bureau, saying that the organisation looks forward to working with fellow state and federal regulators “to enforce the law against bad actors,” acknowledging that payday advance products are subject to state limitations. 

New York is prepared to take them up on this offer. Regulators from ten states and Puerto Rico have formed a coalition which is currently probing companies in this new category of micro-lenders, including Earnin, which was subpoenaed by New York last spring. The state does not allow high-interest payday loans, while the Earnin app is still available for download by NY residents.

Most of the states involved in the probe do not allow payday lending or have heavy regulations on the market. Overall, however, state regulations vary widely. With states like Montana setting APR caps at 36 per cent and Ohio strengthening regulations with an even lower 28 per cent limit. 

Functionally, it is hard to determine how different earned wage advances are from a payday loan. With Earnin, users are allowed to borrow in a range of $50 to $500, though it is unclear how often a user can borrow and what determines their maximum. Users are then asked to tip anywhere from $0 to $14. The Mann optimism survey points out that most payday lenders charge a fixed fee of about 15 per cent for a loan of two weeks or less – which comes out to $15 per $100 borrowed, and if paid back in two weeks is roughly equivalent to a 391 per cent APR. 

For the frugal Earnin user who tips nothing, the service appears to be essentially free. However, the more generous Earnin user, tipping $14 for a $100 withdrawal, would be looking at an equivalent to a 365 per cent APR for a 14-day term. If you add in the “pay it forward” feature, where users can tip extra to support others in the communities, the annual interest rate translations continue to grow.

Contacted with questions for this article, Earnin claim strongly, “There are no loans, fees or hidden costs.” It wanted it to be clear that it is not in the business of payday lending and is entirely “community supported”. It does not require or suggest tips to its community of users, though a spokesperson tells me that “without tips, Earnin wouldn’t be possible.” But undoubtedly the large sums of venture capital (VC) investment it has received also helps. In December 2018 alone, Earnin raised $125m from Silicon Valley investors. 

It is not surprising that VC funds see such promise in the Earnin business model once you translate “tips” into interest rates that top out above many states’ APR cap. Users tipping just $1 on a $100 two-week advance are looking at an equivalent annual interest rate of 26 per cent – in range with high-interest credit cards.

The cash from VC funds will likely aid Earnin in diversifying its financial services. The company has announced plans to start offering assistance to users with negotiating medical bills, applying the “pay-what-you-want” model to this segment as well. This may also help to further distance themselves from payday lenders amid state probes. 

Earnin wants to be seen as a fintech solution, not a payday lender. And while it holds an Apple app store rating of 4.7 stars, reading through its reviews shows some teething problems. Some users report their account balance failing to update in the app, bank drafts debited days earlier than usual causing overdrafts, and other technical glitches that can be costly to users. 

It seems a glaring problem if the dreaded overdrafts fees Earnin claims to solve are still happening on its platform. And for Buckley Stevenson, funds being drafted early caused issues beyond just fees. 

When Buckley first used the Earnin services, the amount he owed was taken from his account three days early, before he was paid, thus overdrawing his account and inadvertently taking money transferred to him by his employer to be used to purchase work equipment. After unsatisfying replies from the Earnin customer service team, he wrote on Facebook “Could lose my job. Their excuse? They did it so they can post it to my Earnin account on the 12th. Refused to help, and just copy [and] paste scripts after answering your initial concern.”

When asked how its customer service team dealt with such errors, a spokesperson replied: “We always repay the community member as quickly as possible … Our goal is to make sure this never happens, but when it does, we refund the overdraft fee entirely and make sure the community member is made whole.”

Buckley told me that Earnin did offer to reimburse his fees but he did not have any with his bank – what Earnin could not solve was his equipment issue. “I was not able to get my equipment that day... [which was] embarrassing because I was wearing my company logo, and my payment was declined for no funds.” 

Luckily, Buckley was able to keep his job after explaining the story to his manager, providing bank statements and chats with Earnin as proof. Still, he said, “It definitely did cause some trouble for her because the register was short and we had no receipt or anything to explain why.”

Earnin is a non-recourse product, meaning it gives out money without any right to collect it. However, its terms of service give it sweeping access over consumers banking data, meaning it can draft whenever its algorithm sees fit. 

I asked its spokesperson what happens if a user doesn’t have funds in the account to repay their loan and “tip” or default on these micro-loans, they claimed the “simply pause their account.” When asked how many times it will attempt to get repayments, the spokesperson stated: “Earnin is compliant with CFPB’s Payday, Vehicle Title, and Certain High-Cost Installment Loans Rule with no more than two attempts.”

The fact of the matter, though, is that it doesn’t have to be compliant. 

Hawkins feels federal certainty through regulation would protect both companies like Earnin against state actions and consumers from harm. I also asked Thomas Miller, a finance professor from Mississippi State University and a well-known researcher of consumer credit, specifically small-dollar instalment loans, where he thought regulations needed to go in terms of these emerging app-based lenders. 

“All I think they should do is ensure a level playing field and make sure there aren’t fraudsters at work. Then, let the market decide what the maximum amount people can borrow and the maximum amount they are willing to ‘tip’ or pay,” Miller said, with a derisive chuckle at the word “tip”.

Regulators will need to decide what to do with this fast-growing high-cost micro-loan market, but so far the Trump administration has shown no interest in regulating this sector, so, for now, these cash advance apps will likely continue to operate on the fringes and consumers will be left to decide on their own if Earnin really represents a better deal than traditional payday loans – however low a bar that may be.

Originally from Texas, Gabrielle Webster is a DC-based writer who covers business and economic issues.