Square launches point-of-sale consumer installment loans

Last week we learned that Square, best known for its small business credit card processing service, is getting into the consumer lending business. Lending isn’t new to Square, they launched Square Capital in 2014 to help their small business customers access capital. But they’ve never offered a direct-to-consumer financing option until now.

While the typical transaction on Square is small, they’ve had over 36 million transactions over $250 in the past year. And these are the transactions they pursue with their new Square installments product.

Loans will range from $250 to $10,000 and have terms of three, six or twelve months. Interest rates will range from 0% to 24% APR. The application process is quite simple, applications can be completed in-store on the customer’s phone and most applications will be approved or rejected instantly. Square bears the credit risk as the customer repays the loan directly to Square and the merchant receives the full amount of the sale.

The way it works is that the customer, once approved, receives a virtual credit card number to provide to the merchant to process the transaction and trigger the loan. Interestingly, they quote APRs starting at 0%. Since Square will generate significant revenue from merchant processing fees, I could see how offering a super-privileged customer a 0% loan might make sense for them in certain situations.

In this CNBC article they give the example of a small business owner who participated in the pilot program and was able to increase his sales by 20% to 30% by offering installment loans. The average loan amount for this trader was around $4,000.

Square is entering an increasingly crowded market for point-of-sale financing. Affirm has issued over $1 billion in point-of-sale installment loans with over 1,000 merchants on board now. PayPal has its PayPal Credit product offering financing on amounts of $99 or more. Then there’s fintech startup LendingUSA, CareCredit in healthcare, GreenSky in home improvement, and AfterPay, the successful Australian company looking to expand into the United States. Not to mention the historic banks with their old point-of-sale business.

That said, Square has a big advantage with its massive customer base. It is supposedly simple for a trader to sign up for this program, they say it only takes 10 minutes. After signing up, the merchant is really in a no-win situation offering credit, because Square is taking the risk.

Square Capital has grown its small business lending business over the past few years. In the second quarter, they facilitated $390 million in business loans or cash advances, a 22% increase over the prior year. This makes it one of the largest small business lenders in the country. Their new installment loan business will also fall under Square Capital.

What will be interesting to see is if Square goes to the capital markets to fund Square’s installments. With their small business financing operation, most of the capital comes from outside investors with just $85 million in loans on Square’s balance sheet at the end of the second quarter.

my catch

The success of Square Installments, given that they have successfully acquired customers, will depend entirely on subscription. They are new to consumer lending and therefore untested in this area. Although they have had success in financing small businesses, providing an unsecured loan to consumers is a very different operation.

The good news for Square is that there are plenty of people with experience in this process, and we’ve come a long way over the past few years in our ability to underwrite loans instantly. I read that they will use machine learning to determine the creditworthiness of borrowers, which is a no-brainer.

I have no doubt that Square will be able to attract a large number of customers for its service. And given the short-term nature of these loans, they will be able to quickly see the results of their underwriting and adapt if necessary. By funding their own balance sheet, they can afford to take their time to learn.

I’d be very surprised if Square didn’t become a major player in point-of-sale financing in the near future.

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