When the U.S. Federal Reserve cut interest rates by half a percentage point last week, it was good news for fintechs, one of the most at-risk startups, especially venture capitalists who back startups that rely on loans for cash flow to run their businesses. It was.
These companies include corporate credit card providers like Ramp or Coast, which offer cards to vehicle owners. Card companies make money through currency exchange fees, or transaction fees, charged to merchants. “But they have to take out loans to raise money,” said Sheel Mohnot, co-founder and general partner at fintech-focused Better Tomorrow Ventures.
“Loan conditions have improved.”
Affirm, a buy now pay later (BNPL) company founded by Max Levchin, a famous PayPal mafia member, is a good case study. Affirm, which went public in 2021, is no longer a startup, but its stock price has plummeted as interest costs have risen, falling from about $162 in October to less than $50 per share since February 2022.
BNPL pays the seller the full amount upfront. We then allow the customer to pay for the item interest-free over several payments. Many BNPLs primarily generate revenue by charging sellers a fee for each transaction processed on their platform rather than interest on purchases. Their business model did not allow them to pass on the dramatically high costs they incurred.
“BNPL was making money when interest rates were zero,” Mohnot said.
Affirm is competing with a number of BNPL startups. Klarna, for example, has been anticipating an IPO for years but is not yet ready for 2024, its CEO told CNBC last month. Some BNPL startups didn’t survive at all, like ZestMoney, which shut down in December. Meanwhile, other lending fintech companies have also shut down due to high interest rates, such as Fundid, a business building credit card.
It may seem counterintuitive, but lower interest rates are good for fintech companies offering loans. For example, car loan refinance company Caribou falls into this category, predicts Chuckie Reddy, partner and head of growth investing at QED Investors. Caribou offers 1-2 year loans.
“Their whole business is premised on being able to move from higher rates to lower rates,” he said. Now that Caribou’s financing costs are lower, it should be able to reduce the costs it charges borrowers.
Solar panel loan provider GoodLeap and Kiavi, a lender specializing in loans for “fix and flip” home investors, are other short-term lenders expected to benefit. Rudy Yang, a fintech analyst at PitchBook, said that like Caribou, it could potentially pass on some of the interest savings to customers, which could lead to a surge in lending volume.
And no sector could benefit from falling interest rates more than fintech startups entering the mortgage lending industry. But it may be a while before the recently worn-out space is revived. Although the Fed’s cuts were large, interest rates are still higher than the previous ZIRP (Zero Interest Rate Policy) era when the Fed’s interest rates were close to zero. The new Fed interest rate is currently in the 4.5% to 5% range. So the loans available to consumers will still be a few percentage points higher than the base Fed rate.
If the Federal Reserve continues to cut interest rates, as many investors hope, many people who bought homes during times of high interest rates will look for better deals.
“The wave of refinancing will be huge, but not tomorrow or in the next few months,” said Kamran Ansari, venture partner at VC firm Headline. “It may not be worth it to refinance 0.5%, but if interest rates go down 1% or 1.5%, you’ll start to see a flood of refinances from all the people who have had to suffer on their mortgages. At a higher rate in the last few years.”
Ansari expects a significant rebound in mortgage fintechs such as Rocket Mortage and Better.com, which have performed poorly in recent years.
After that, VC investors’ money will almost certainly flow. Ansari also predicted that as interest rates become more attractive, there will be a surge in new mortgage technology startups.
“Any time you look at a space that has been dormant for four or five years, there will be an opportunity for reinvention and updated algorithms that can now do AI-driven underwriting,” he said.
