When the U.S. federal government cut interest rates by half a percentage point last week, it was good news for venture capitalists backing a particularly struggling class of startups: fintechs, in especially those who rely on loans to obtain liquidity to operate their businesses.
These companies include corporate credit card providers like Ramp or Sidewhich gives maps to fleet owners. Card companies make money from interchange rates, or transaction fees, charged to merchants. “But they have to front the money by getting a loan,” said Sheel Mohnot, co-founder and general partner of Better Tomorrow Ventures, a fintech-focused firm.
“The conditions of this loan have improved. »
Affirm, a buy now, pay later (BNPL) company founded by notorious PayPal mafia member Max Levchin, is a good case study. Although Affirm is no longer a startup – having gone public in 2021 – when interest costs increased, its stock price fell from around $162 in October to less than $50 per share since February 2022.
BNPLs pay the full amount to merchants in advance; they then allow that customer to pay for the item in a few payments, often interest-free. Many BNPLs generate revenue primarily by charging merchants a fee for each transaction processed on their platform, not interest on the purchase. Their business model did not allow them to pass on the significantly higher costs they were incurring.
“BNPLs made a ton of money when interest rates were zero,” Mohnot said.
Affirm competes with a host of BNPL startups. Klarna, for example, is a player whose IPO has been expected for years. but is still not ready in 2024, its CEO told CNBC last month. Some BNPL startups didn’t survive at all, like ZestMoney, which closed its doors in December. Meanwhile, other lending fintechs have also closed their doors due to high interest rates, like credit card for business creation Fundid.
As counterintuitive as it may seem, lower rates are also beneficial for fintechs that offer loans. Auto loan refinancing company Caribou, for example, falls into this category, predicts Chuckie Reddy, partner and head of growth investing at QED Investors. Caribou offers loans of one to two years.
“Their whole business is based on the ability to move you from a higher rate to a lower rate,” he said. Now that Caribou’s financing costs are lower, they should be able to reduce what they charge borrowers.
Other short-term lenders expected to benefit include GoodLeap, a provider of solar panel loans, and Kiavi, a lender specializing in loans for “fix-it” real estate investors. Much like Caribou, they can potentially pass on some of their interest savings to customers, leading to increased loan origination volume, said Rudy Yang, a fintech analyst at PitchBook.
And no sector should be helped as much by falling interest rates as the fintech startups taking on the mortgage industry. However, it may be some time before this recently challenged space sees a resurgence. Although the Fed’s reduction has been significant, interest rates remain high compared to the long ZIRP (zero interest rate policy) period that preceded it, when Fed rates were near zero. The Fed’s new rates are now in a range of 4.5% to 5%. So loans available to consumers will always be a few percentage points above the Fed’s base rate.
If the Fed continues to cut rates, as many investors hope, then many people who bought homes during the period of high rates will be looking for better deals.
“The refinancing wave is going to be massive, but not tomorrow or in the next few months,” said Kamran Ansari, a venture partner at venture capital firm Headline. “It may not be worth refinancing for half a percent, but if rates go down a percent or a percent and a half, then you’ll start to see a flood of refinances from everyone who has been forced to bite the bullet on a mortgage at the highest rates over the past two years.
Ansari predicts a significant rebound for mortgage fintechs like Rocket Mortage and Better.comafter a sluggish performance in recent years.
After that, money from venture capitalists will almost certainly flow. Ansari also predicted an increase in new mortgage technology startups if interest rates become more attractive.
“Anytime you see a space that has been dormant for four or five years, there are probably opportunities to re-invent and update the algorithms, and now you can do AI-centric underwriting,” he said .