Social change work is hard and frustrating and wonderful and terrible; it is also, at times, funny, quirky and just plain fascinating. With this blog we hope to capture all that goes into what we do at Capital Good Fund, and we invite you to join the conversation!

Saturday, November 8, 2014

Ideas For Serving Deeply Vulnerable Populations

Yaay Equitable Financial Services!
There are a lot of wonderful things about the use of financial services as a tool to tackle poverty: it respects the dignity of the poor; generates a revenue stream for the lender; builds the borrower's credit; and allows borrowers to make investments, such as in a security deposit or computer purchase, that they would otherwise be unable to make.  One challenge, however, is that there is an inherent tension between making loans to the poor and maintaining high repayment rates: the lower the income of the borrower, the riskier the loan.  This is not due to any character flaws on the part of the poor, but rather the instability--financial and otherwise--that often defines their lives.

Given that our poverty-fighting mission, it is imperative that we figure out how to make loans to deeply vulnerable populations without taking on an unacceptable level of risk.  Many of our referrals come from caseworkers and agencies that work with the temporarily homeless, the mentally ill, ex-offenders and survivors of domestic violence, and there it is very frustrating to deny a loan application that can transform the life of the applicant--a loan to cover the cost of a security deposit for a homeless family, for instance.

As a nonprofit, we make loans to those unlikely to receive a loan from a mainstream financial service provider.  Our clients must either go to predatory lenders, such as payday lenders (who charge 260% APR), or forego the expense.  We are proud that 20% of our borrowers have no credit score, and the average FICO for the remaining 80% is 590.  What's more, the average household income ranges from a paltry $20,000 to moderate $35,000 (depending on the loan product).

So what's the problem?  Despite our success, we are not making as many truly transformational loans as we would like.  Fortunately, I've got a few ideas for how to address this:

Leverage payee relationships.  Some low-income families opt to designate a "payee" to manage their income; or a judge can appoint one, such as in instances where the individual is too ill to mange their own money.  The payee's job is to receive the person's income on their behalf, and to then spend it based on their desires.  For example, the payee might be instructed to first pay the person's rent and utilities and then their car payment; after that, the remaining funds might be distributed to the person for them to spend as they see fit.  What this relationship allows is for us to make a loan guaranteed by the payee.  In other words, the payee may be instructed to include us in the list of creditors paid before the person can use the income for other purposes.
There are several advantages to this model.  Consider someone on a fixed income whose car breaks down. They have terrible credit, lack a bank account and have no savings.  Ordinarily, we would have a hard time approving the loan.  However, if the payee guarantees the loan, we can enable the borrower to repair the car, keep their job and build their credit, and to do so without much risk of default.  Nothing is risk free, though: the borrower can revoke the payee's ability to manage their funds; they might lose their public benefits (such as if they are convicted of a felony); and the payee might turn out to be unreliable.  For these reasons, we would only work with nonprofits or attorneys who serve as payees, thereby mitigating the aforementioned risks.

Use automatic payroll deductions. Another way to mitigate risk is for the lender to get paid back through an automatic payroll deduction from the borrower's employer.  This obviously requires that the borrower be employed, and carries the risk that the borrower lose their unemployment.  Still, there is an emerging trend of using this technique to combat predatory lending and to make loans to low-wage workers.  A good example is a program in Texas run by the Community Loan Center of Texas and Texas Community Capital.  It works as follows: "Employees of participating employers may borrow up to $1,000 at 18% interest with up to 12 months to repay...Employees apply for the loan online and when approved, the funds are wired into their bank account.  The loan is repaid through convenient payroll deduction."  (Learn more about this model here)

The loans have only had a 5% loss rate, and the cost savings are huge: in Texas, the average $300 payday loan accrues $701 in fees and interest before being paid off!  By replicating this model, we can make critical loans to low-wage worker--such as those working in fast food, hospitality and the building trades.

Partner with nonprofits and funders.  Finally, we have begun partnering with organizations such as Year Up Providence and Crossroads Rhode Island to make loans to their participants.  The agency and / or a funder guarantees them, thereby lowering our risk.  The only downside--and it's a significant one--is that the loan guarantees don't do anything to improve repayment rates; as a result, the borrower's credit score is liable to be damaged.  To counter this, we work with the partner agency's caseworkers to vet the applicants and ensure that their other needs are met.

We are always looking to find ways to serve the poor, the marginalized and the vulnerable. What ideas do you have?  Share them in the comments section!