ZestCash Uses Big Data to Make Tiny Loans

When Douglas Merrill’s sister-in-law asked him for a few hundred dollars to buy new tires so her old car would stop slipping on icy roads in winter, he obliged. It’s not a big deal for Merrill, the former CIO of Google (s goog) who joined that company pre-IPO in 2003. But it was a big deal for his sister-in-law, he says, who is “right on the edge of the poverty line with three kids.”

ZestCash CEO Douglas Merrill

The alternative to asking a benevolent rich family member is to get a payday loan, as 30 million Americans did last year, but payday loans are “fundamentally abusive,” says Merrill. The average payday loan is $300, which borrowers can extend every two weeks (at a cost of $60 per extension) for an average of four months. The borrower’s average total fees are $420 on top of the $300 loan, according to Merrill. That’s an awful deal, but it’s pervasive, with “more payday loan stores in the U.S. than Starbucks (s sbux) and McDonald’s (s mcd) combined,” as Merrill puts it.

Merrill set out to build a company that would provide loans of up to $500, which are paid back in installments that go toward both interest and principal. Called ZestCash, Merrill’s Hollywood-based startup launches tomorrow in the Utah market.

So great; ZestCash is providing an alternative to predatory lending practices. But how does Merrill plan to make this a good business? That’s where his Silicon Valley tech startup experience and approach is coming in handy, he says. ZestCash will quickly complete “massive-scale data analysis” about a potential borrower rather than doing a traditional credit check.

“One of the lessons of the Internet is there’s vast quantities of data, and by using it cleverly you can make a better decision,” says Merrill. This underwriting analysis process is the company’s “special sauce,” says Merrill. The one example he would provide is that a person who has regularly paid her phone bill is extremely likely to pay off a loan on time. In addition to good underwriting ZestCash also thinks it can maximize its chances of getting its money back by doing three things:

  • Making a loan come from a real person. To take out a ZestCash loan, a borrower fills out a web form, and then shortly thereafter receives a phone call from a ZestCash relationship manager. The ZestCash representative makes the decision to lend in the course of a short phone call, and deposits the money in the borrower’s bank account within 24 hours. The borrower gets the direct phone number and email address of the ZestCash rep, and can call them with any issues. The ZestCash rep is given flexibility — much more so than the traditional customer service rep — to do things like skip the latest installment if the borrower calls asking for forgiveness.
  • Setting a payment schedule from the outset. Research shows that borrowers who select their own payment plans are more likely to complete them, says Merrill, a psychology PhD.
  • Not changing the rulebook. ZestCash co-founder and Chief Risk Officer Shawn Budde formerly ran Capital One’s (s cof) sub-prime credit card portfolio. Though that might be a taboo credential these days, Merrill says ZestCash is using the same financial models as Capital One, with an origination fee, interest rate, and cost modeling.

[inline-pro-content]ZestCash plans to advertise extensively both online and offline to attract new customers, though it will operate entirely online. How will it convince customers that it’s not just another too-good-to-be-true scam? “We’re focusing very hard on being completely transparent,” says Merrill. “We’re radically different because we have not organized our business to rely on late fees.”

ZestCash has seven full-time employees, is about a year old, and is funded by Merrill, Flybridge Capital Partners and GRP Capital.

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