'Tips' & 'Donations' Can Reach 1,916% APR on Small Loans

Red Flags for Visa Fast Track Member SoLo Funds Go Beyond High Costs

Hey all, Jason here.

I really think of the fintech ecosystem as a community. Whether a startup, bank partner, vendor, or even regulator, everyone has a role and responsibility to play in protecting the integrity of the financial system.

“Bad actors” — even when well intentioned — erode consumers’ trust in the system and are likely to draw increased regulatory and legislative scrutiny for all participants.

This week, I take a deep-dive on a startup that, though well-intentioned, raises a number of red flags and begs the question, what due diligence are investors, bank partners, vendors, and payment processors doing before partnering with nascent fintechs?

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Despite Significant Risks, SoLo Funds Raises $10M, Partners with Visa, Evolve Bank, Kiva

SoLo Funds, a member of Visa’s Fast Track program and self-described community for creating “mutually beneficial outcomes” for lenders and borrowers, just announced a $10 million equity raise, including from high-profile names like Techstars, Endeavor Catalyst, Taavet Hinrikus (CEO and co-founder, TransferWise), Jewel Burks (Head of Google for Startups), among others.

However, upon closer inspection, the platform’s loan terms raise some red flags. For instance, a typical $50 loan on the platform comes with a $6 “tip” and a donation from $3.50 - $4.50, which, combined, can be significantly more expensive than the predatory loans SoLo purports to disrupt.

At the time of writing, every visible $50 loan request offered a $6 tip

SoLo: a “community” to disrupt payday lending

SoLo Funds bills itself as a community that offers “non-predatory,” “reputable” small-dollar loans as an alternative to payday loans. Its website states:

“SoLo was formed in 2018 to create a viable, non-predatory option for moments when life happens. We tap into the power of community and generosity to form an online safety net that is mutually beneficial to all of our members.”

At its core, the concept is the same as original “peer to peer” fintech pioneers like Lending Club and Prosper - matching individual “lenders” looking for a return with borrowers -- however, there are some important and potentially problematic differences with how SoLo Funds structures its products and services.

Quick Primer: How Established Peer to Peer Lending Is Structured

The idea of “peer to peer” lending is, at this point, well-traveled territory. While Lending Club recently completed its acquisition of Radius Bank and is winding down its retail platform, it still serves as an example of an approach to peer to peer lending that has evolved to comply with lending and securities regulations.

A simplified overview of the Lending Club process:

• A potential borrower applies for a loan

• Lending Club uses credit bureau and application data to underwrite the applicants and generate loan offers, assessing a loan grade from “A” to “G”

• If the borrower accepts an offer, the loan is listed on Lending Club’s platform

• Potential investors can view application attributes, including loan amount, duration, grade, purpose, and tradeline data (but not personally identifiable information)

• Users can commit to buy a fractional participation stake in the loan (as low as $25), which is technically a security that Lending Club refers to as a “note”

• When the amount of the loan is fully committed, Lending Club’s licensed bank partner, WebBank, issues the loan

• Lending Club subsequently buys the loan from WebBank, collects the committed amount from Note investors, and issues the Note security to investors

• Lending Club then acts as servicer for the loan, collecting payments from the borrower and issuing payments to investors who hold a security interest in the loan

How SoLo Funds Structures Its Product

SoLo has taken a significantly different approach to how it legally structures its product.

Instead of serving as a lender itself and selling stakes in the loans it writes, SoLo positions itself as a “marketplace” between the borrower and an individual person acting as the lender.

In its terms and conditions, it asserts that SoLo is neither a lender nor engaged in brokering or origination of loans (emphasis added):

The Platform. The Platform provides a means by which you may: (1) as a “Borrower,” submit an application (“Application“), and subject to the discretion of other users, obtain a personal loan (“Loan“); and/or (2) as a “Lender,” evaluate Applications and subsequently fund Loans. SoLo is not engaged in the brokering or origination of loans made through the Platform, but merely provides a marketplace for Borrowers and Lenders.

However, SoLo states that it does determine user eligibility for the platform and the borrower’s maximum loan amount - including conducting a credit inquiry (“soft pull”), and using that credit data along with social media data to generate a proprietary credit score for the purpose of lenders making a credit decision (emphasis added):

SoLo Score. You authorize us to utilize data contained in your Application, including supporting documentation provided, information related to your social media accounts, and a credit report, to develop a proprietary score (the “SoLo Score“). The SoLo Score will be provided to prospective Lenders to assist in the making of a credit decision without receiving a copy of any such credit report or your Application.

SoLo lists borrower loan requests on its platform, including the borrower’s first name and last initial, SoLo Score, prior loan history with SoLo, loan details, and even, in some cases, a photo of the borrower.

Red Flags Go Beyond “Tips” Business Model

Already, there are a number of red flags warranting further scrutiny with this structure.

No Lending License

In the absence of a national bank partnership, like in the Lending Club model, consumer lending in most states requires a license and adherence to a complicated patchwork of state and federal laws and regulations.

SoLo goes out of its way to assert that it is not a lender but a marketplace for borrowers and lenders. If we take this at face value, the individuals funding the loans would be considered the lender, which is what is stated in the SoLo-generated loan agreements -- and, presumably, be subject to any state licensing requirements and regulations.

My loan agreement for a $50 loan with $60.50 repayable

May Meet Definition of Broker

Despite its attempt to define itself otherwise, SoLo’s model may be considered to be brokering a loan under various state laws. For instance, in Illinois’ Loan Broker Act, a loan broker is defined as (emphasis added):

"Loan Broker" means any person who, in return for a fee, commission, or other compensation from any person, promises to procure a loan for any person or assist any person in procuring a loan from any third party, or who promises to consider whether or not to make a loan to any person.

At face value, SoLo would appear to meet this definition. Loan brokers in Illinois are required to be registered and provide specific broker disclosures to borrowers.

Acting as a Consumer Reporting Agency

Taking SoLo’s structure at face value, SoLo could be construed as acting as a consumer reporting agency. Under the Fair Credit Reporting Act, a consumer reporting agency is defined as (emphasis added):

The term “consumer reporting agency” means any person which, for monetary fees, dues, or on a cooperative nonprofit basis, regularly engages in whole or in part in the practice of assembling or evaluating consumer credit information or other information on consumers for the purpose of furnishing consumer reports to third parties, and which uses any means or facility of interstate commerce for the purpose of preparing or furnishing consumer reports.

SoLo, in its own terms and conditions, states that it uses a borrower’s credit report and social media data to generate its SoLo Score for the purpose of assisting potential individual lenders in making a credit decision (emphasis added):

SoLo Score. You authorize us to utilize data contained in your Application, including supporting documentation provided, information related to your social media accounts, and a credit report, to develop a proprietary score (the “SoLo Score“). The SoLo Score will be provided to prospective Lenders to assist in the making of a credit decision without receiving a copy of any such credit report or your Application.

There are considerable regulatory requirements for consumer reporting agencies that SoLo would need to comply with, were it to be considered a CRA.

Acting as a Debt Collector

SoLo states its terms and conditions that, in the event of loan default, SoLo will attempt to collect for 90 days. As SoLo is the servicer of the loan prior to default, it can argue that FDCPA doesn’t apply to it, but state debt collector licensing requirements could apply -- including in states where SoLo has stated it has facilitated a significant number of loans, like Illinois and Texas (emphasis added):

Debt Collection. For a period of 90 days, SoLo will proactively attempt to collect payment on defaulted loans prior to loans being placed with an external collections agency. Upon successful collections, Lender agrees to pay SoLo a recovery fee. In the event SoLo is unable to collect, Lenders will have the option of entering into a third-party debt collector relationship managed by SoLo, for such services. A commission fee of 30% of the total amount recovered is retained by the collections partner.

It’s unclear how or if SoLo complies with state debt collection requirements and borrower protections.

ECOA and Fair Lending Compliance

It is unclear how SoLo and its third party lenders’ work to ensure fair lending compliance.

Prohibited discrimination on the basis of a protected class (race, gender, etc.) could occur in how SoLo conducts credit scoring, particularly as it states that it uses social media data, in how it determines eligibility, and/or in how lenders on the platform determine which borrowers to fund.

Inclusion of borrowers’ names and, in some cases, photos exacerbates fair lending risk by potentially making protected variables like race, gender, and age known to the lender.

Other Potential Issues 

Acting as a Money Services Business: other marketplace lenders are typically exempt from registering as money services businesses (MSBs) under the “agent of the payee” exception; as SoLo Funds appears to argue it isn’t an agent of either party, it may require money transmitter licensing in some states. A search of FinCEN’s registration data reveals no such licenses. 

AML/KYC compliance: SoLo Funds did require government issued ID and customer data (name, SSN, DOB, address) during onboarding, but it is unclear to what extent it has an AML/KYC program; the standard PATRIOT Act disclosure was not present at onboarding.

Tax Reporting and Compliance: the “tip” payments lenders on SoLo’s platform are earning should likely be treated as income for tax purposes. While SoLo Funds does require users to certify they are not subject to backup withholding during onboarding, it is unclear how it handles tax reporting and compliance for lenders on its platform or if users acting as lenders understand they may be incurring a tax liability.

So, You Want to Write Small Loans in Illinois…?

To make further analysis of SoLo’s model and products meaningful, it helps to use a specific state example.

In Techcrunch’s coverage of its recent equity raise, SoLo states that it is financing “tens of thousands” of loans per month, with much of its activity coming from California, New York, Texas, and Illinois.

New York has a de facto ban on small-dollar lending, as its state law limits interest rates to 25% per annum. California, Texas, and Illinois currently permit small-dollar lending in various forms, though in each it is highly regulated and requires appropriate state licenses.

In order to get a better idea of how SoLo works, I applied for (and accidentally accepted proceeds of) a SoLo-arranged loan in Illinois.

Before analyzing the SoLo-arranged loan in Illinois, it helps to understand the core tenets of lending law in Illinois (though Illinois law is set to become even more restrictive, if the Predatory Loan Prevention Act is signed into law.)

Requirements to be a Small Dollar Lender in Illinois

Illinois law has defined a number of small-dollar products, including “Small Consumer Loans,” payday loans, and payday-installment loans. Based on the parameters of the product SoLo is offering (max $50 for first time borrower and a loan term between 5-15 days), it is most closely aligned with a payday loan under Illinois law and arguably should be governed by Illinois’ Payday Loan Reform Act.

Illinois law requires any person or entity engaged in making payday loans to hold a license. Further, examining Illinois’ definition of “lender” would appear to encompass the activities in which SoLo itself is engaging (emphasis added):

"Lender" and "licensee" mean any person or entity, including any affiliate or subsidiary of a lender or licensee, that offers or makes a payday loan, buys a whole or partial interest in a payday loan, arranges a payday loan for a third party, or acts as an agent for a third party in making a payday loan, regardless of whether approval, acceptance, or ratification by the third party is necessary to create a legal obligation for the third party, and includes any other person or entity if the Department determines that the person or entity is engaged in a transaction that is in substance a disguised payday loan or a subterfuge for the purpose of avoiding this Act.

Based on its own statements and a search of Illinois records, SoLo Funds does not hold such a license in Illinois; it’s also fair to assume that the individual ‘lenders’ on SoLo’s platform do not hold such licenses.

Further, Illinois Payday Loan Reform Act makes clear that it applies even to persons or entities that may seek to evade it (emphasis added):

The provisions of this Act apply to any person or entity that seeks to evade its applicability by any device, subterfuge, or pretense whatsoever.

Restrictions on Small-Dollar Lending Products You Can Offer In Illinois

Illinois law sets fairly clear parameters for single payment small-dollar loans:

• a maximum of the lesser of $1,000 or 25% of the borrower’s gross income

• a minimum term of 13 days and a maximum of 45 days

• a maximum fee of $15.50 per $100 borrowed

Apart from the $15.50 per $100 loan fee, a one-time NSF fee of up to $25 for returned transactions, and a $1 Veritec verification fee, no other fees are permitted (emphasis added):

“a lender may not impose on a consumer any additional finance charges, interest, fees, or charges of any sort for any purpose”

Under Illinois law, there are additional requirements on the lender (whether that is SoLo or the third party individual funding the loan):

• verification a borrower is eligible via a state-mandated database (eg “Veritec”)

• verification of a borrower’s gross income with official documentation, such as a pay stub or benefits receipt

• state-mandated disclosures, in English and Spanish, that explain a consumer’s rights and responsibilities

Do SoLo-facilitated Loans in Illinois Meet these Requirements?

To understand more about the exact terms SoLo offers, I signed up and requested a loan using my address in Illinois.

The terms of my $50 loan in Illinois

The TILA Disclosures -- Showing $0 Finance Charge and 0% APR. It was not possible to view the actual loan agreement before “signing” it.

SoLo calculated my SoLo Score (54) and would permit me to request $50 (neither more nor less).

It’s unclear exactly how the SoLo Score is determined, as my underlying credit report is good (800+ FICO), my linked bank account has a long positive balance history, and my linked social media profile is active and was established in 2005.

While SoLo claims not to have any finance charges and thus a “0%” APR, it does assess both a lender “appreciation tip” and a “donation” to SoLo itself.

Plenty of other fintechs leverage “tips” as part of their business model and defend doing so by stating that the tip amount doesn’t impact loan or amount eligibility.

SoLo Isn’t the only fintech relying on “tips” or membership fees, practices that are currently under investigation by a number of state regulators

SoLo’s approach is notable for a couple reasons:

• the proposed tip is listed as part of the borrower’s loan request

• potential lenders can “counter” and request a higher tip from the borrower

• the SoLo-suggested tip is a percent of the principal, de facto linking the size of “tip” with the loan size for which someone can qualify

  While you can list a loan request with a $0 tip, SoLo itself acknowledges these loans are less likely to be funded (eg negatively impacting a borrower’s eligibility)

• and the tip is agreed and committed to by the borrower before taking the loan

In addition to the “tip,” which goes to the third party lender, SoLo assess a “donation” that it keeps for itself. While it’s possible to turn off the donation, this isn’t immediately apparent in the normal course of applying for a loan, but rather is buried in the user settings.

The SoLo “donation” basically functions as an origination fee. The donation is paid by the *lender* at the time the loan is funded, but is added to the borrower’s loan and is “reimbursed” to the lender when the borrower repays the loan.

This is notable, as it means SoLo itself makes money whether or not the loan is actually repaid.

Cost of Loan

There is no default tip amount, though SoLo repeatedly states that increasing the size of tip will increase the speed and likelihood of funding and encourages users to leave the maximum tip possible.

The “donation” amount is defaulted to 8% of the principal which, on a $50 loan, is an additional $4.

SoLo states that the size of tip impacts the likelihood and speed of funding

The maximum combined tip and donation on $50 is $10.50, or $21 per $100 borrowed, which is well in excess of Illinois $15.50 per $100 cap. If computed as an APR, this would equate to a 1,916.25% APR on a permitted 4-day loan term.

Verification and Disclosure Requirements

It is unclear if SoLo or the third party individual funding the loan are confirming an applicant’s eligibility to borrow in Illinois with the state-mandated database, Veritec.

At no time in the process of applying for or funding my loan did SoLo or the lender request official documentation of my income.

For small-dollar loans that arguably should fall under the Illinois Payday Loan Reform Act, a variety of disclosures are prescribed.

Neither SoLo nor the matched lender provided any such disclosures. In fact, I wasn’t even able to view my loan agreement before inadvertently “signing” it, causing the funds to be disbursed to my account.

SoLo Funds Transactions Processed via Visa Direct

Partners with Evolve Bank & Trust, Kiva, and “Backed” by Visa

Throughout its terms and conditions, SoLo Funds references platform users agreeing to open accounts with partner bank Evolve Bank & Trust, though it’s unclear what purpose these accounts serve.

SoLo states that it partners with 501(c)3 non-profit small business lender Kiva, though the arrangement seems limited to a loosely worded co-marketing arrangement.

Additionally, SoLo is a member of Visa’s Fast Track program and uses Visa Direct to push loan proceeds to borrower cards. On SoLo’s site, it alternately states that it is “backed” by Visa and that Visa is a “partner.”

SoLo Funds’ Response

I shared a pre-publication draft with the team at SoLo. In a call with its co-founders, they defended the business model, and pointed out that as users progress on the platform, the terms of the loans improve, with loan requests for $500 typically offering tips that are a lower percent of principal. (Even if this is the case, the majority of the loans reviewed on the platform are lower dollar amount with proportionally higher ‘tip’ + ‘donation’ charges. SoLo’s UX encourages users to choose higher tip amounts to increase the likelihood of their loan being funded, and it places the option to turn off ‘Donations’ in a separate user setting that must be toggled for every new loan request.)

The co-founders also wanted to clarify that SoLo isn’t actually pulling any credit data (even a “soft pull”), and that references to credit report authorization are included in the T&Cs to give them the flexibility to do this in the future. (This raises more questions than it answers: how is SoLo underwriting these loans? Do the individual lenders on the platform mistakenly believe that SoLo has done a soft pull?)

Asked about its relationship with SoLo Funds, Visa shared this statement:

Visa is not an investor in SoLo Funds. SoLo Funds is part of Visa’s Fast Track program, which helps fintechs connect with Visa certified partners to build and launch payment solutions more quickly. Just like any other Visa partners, Fast Track program participants must comply with applicable laws and guidelines, including state and federal lending requirements, before launching a new Visa program or offering a Visa product or service.

I reached out to Kiva and Evolve B&T, neither of which responded to my request for comment.