If you’ve shopped online recently, you may have seen Affirm on the checkout page, next to the familiar options to pay with a credit or a debit card. If not, you will probably notice it over the holiday shopping season. Affirm combines the ease of paying online with the repayment schedule of Bad Credit Installment Loans from Direct Lenders.
Yes, thanks to financial technology, a new kind of lending business has emerged.
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Affirm was founded by PayPal Holdings (ticker: PYPL) co-founder Max Levchin, along with a co-founder of the data-mining firm Palantir and a data executive at videogame publisher Ngmoco.
Yet Levchin says he didn’t start out trying to create a lender. Instead, he wanted to disrupt the credit score, a closed-off and opaque system that consistently disadvantages groups like recent immigrants and the young. And credit scores may not even be very good at predicting creditworthiness.
Levchin developed a new way of gauging a consumer’s credit risk and started talking to financial institutions about how to use it to make better underwriting decisions.
“It was almost an academic experiment to try to be a better risk assessor and underwriter,” Levchin tells Barron’s. The response he got was disheartening: The big banks weren’t interested.
But then his interest was rekindled when he heard that millennials don’t like using credit cards because they don’t want the responsibility and don’t understand how the annual percentage rate, or APR, works. Levchin decided that if banks weren’t interested in lending in a fairer, more straightforward way, he would build a company and do it directly.
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With Affirm, an online shopper browses and buys as one normally would, entering email, address, and other personal information. Nothing is really different until you reach the actual payment step. If a merchant has partnered with Affirm, its button shows up as an option. If you click it, you answer a few questions and seconds later you’re shown a payment plan ranging from a few months to 36 months depending on the purchase, with interest rates ranging from zero to 30% APR.
The company has also rolled out a feature for the holiday season that lets shoppers use its website to see where they can use Affirm and browse special offers.
Affirm doesn’t disclose payment volumes, but says it has 1,200 merchant partners. Particularly among select brands where it offers 0%— products like Casper mattresses or Flywheel stationary bikes—it can feel as if Affirm has built in a selection for a younger, if higher-income market. The company has raised a total of $720 million from prominent venture-capital firms like Khosla Ventures, Lightspeed Venture Partners, and Founders Fund, which is run by Peter Thiel, the Trump-backing Facebook director who is a fellow member of what people in Silicon Valley call the PayPal Mafia. (Elon Musk is also a member.)
The idea of point-of-sale financing is not new, of course. For years, retailers like department stores offered wildly below-market interest rates to shoppers who signed up at the cash register for the store-brand credit card.
Those rates, Levchin notes, were low only because the lender expected some percentage of borrowers to fall behind on their payments, at which point huge fees or retroactive compounding interest would start to kick in. In other words, the real money is made when the borrower falls behind, gets confused, or, even better, both.
It’s in part a testament to how opaque, frustrating, and fee-ridden the experience of carrying a balance on a credit card can be for so many people that Affirm’s model can be pitched as a do-gooder project. Yet that’s what Levchin is doing. Affirm instead offers a loan with a specific rate that you pay back over a specific amount of time, and that doesn’t have late fees or random service charges.
“We set out to design a product where the product was fundamentally aligned with the consumer,” Levchin says. And it is wholly unlike the previous generation of point-of-sale lending, he says: “It’s simple interest; it doesn’t compound. There are no fees, no late fees. There’s no fine print.”
Merchants benefit, too, Levchin says, because when buyers feel like they understand the credit terms they are using to make a purchase, they tend to buy more or buy more often, leading retailers to experience an increase of 20% to 30% in sales, he says.
Affirm isn’t alone in trying to use installment lending as an alternative to credit cards.
One company that provides what seems like a similar product is Afterpay, an Australian fintech. Like Affirm, Afterpay partners with merchants to be included as an option at the point of online sale.
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But how Afterpay makes money is different. Technically, the company does not charge any interest at all—a distinction that means it isn’t subject to a whole set of regulations. Instead, Afterpay makes money from late and merchant fees. Its business model means it benefits when customers fall behind on payments. Indeed, late payments make up about a quarter of the company’s revenues. (The rest comes from merchant fees.) An Afterpay spokesperson says its buy-now-pay-later model is cheaper than Affirm if customers pay on time, and can even be cheaper if customers are late.
Variations on the model, if in a far less transparent form, can be found when a telecommunications company sells a new phone by tacking on a charge to each month’s bill for the life of a wireless contract. More significant may be a limited rollout by Amazon.com (AMZN) of a monthly payment-plan option for some product lines.
Levchin says he welcomes a company like Amazon getting into the installment-lending business. It’s a sign that he’s onto something, he says—and he has a head start. The more people who are exposed to this way of paying for purchases, he says, the better.
Writen by Ben Walsh at barrons.com
