VCs expect a wave of startups offering mortgages and other lower-interest loans as the Fed cuts rates

When the U.S. Fed cut interest rates by half a percentage point last week, it was good news for venture capitalists backing a particularly beleaguered class of startups: fintechs, especially those that rely on loans for cash flow to run their businesses.

These companies include business credit card providers such as Ramp or Coast, which issue cards to fleet owners. The card companies make money from interchange fees or transaction fees charged to merchants. “But they have to raise the money by getting a loan,” said Sheel Mohnot, co-founder and general partner at Better Tomorrow Ventures, a fintech-focused firm.

“The terms of that loan just got better.”

Confirm that a buy now, pay later (BNPL) company, founded by famous PayPal mafia member Max Levchin, is a good case study. Although Affirm is no longer a startup — after going public in 2021 — its stock price fell as interest expenses rose, from around $162 in October to below $50 per share since February 2022.

BNPLs pay sellers the full amount upfront; They then let the customer pay for the item in a few installments, often without interest. Many BNPLs generate revenue primarily by charging merchants a fee for each transaction processed on their platform, rather than through interest on the purchase. Their business model did not allow them to pass on the dramatically higher costs they were incurring.

“BNPLs were making money hand over fist when interest rates were zero,” Mohnot said.

Affirm competes with a large number of BNPL startups. Klarna, for example, is a player that has been expected to go public 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 shut down in December. Meanwhile, other lenders also shut down due to high interest rates, such as business-building credit card Fundid.

As counterintuitive as it may seem, lower rates are also good for fintechs offering loans. Caribou, the auto loan refinancing company, for example, falls into this category, predicts Chuckie Reddy, partner and head of growth investments at QED Investors. Caribou offers loans of one to two years.

“Their whole business is focused on being able to take 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 the fees they charge borrowers.

GoodLeap, a provider of solar panel loans, and Kiavi, a lender specializing in loans for fix-and-flip home investors, are other short-term lenders expected to benefit. Like Caribou, they may be able to pass on some of their interest savings to customers, leading to an increase in loan volume, said Rudy Yang, fintech analyst at PitchBook.

And no industry should be helped as much by lower interest rates as fintech startups entering the mortgage industry. However, it may take some time before this recently destroyed space experiences a revival. Although the cut the Fed made was a large cut, interest rates are still high compared to the long ZIRP (zero interest rate policy) era that preceded it, when the Fed rate was near zero. The new Fed rate is now between 4.5% and 5%. So the loans available to consumers will still be a few percentage points higher than the Fed’s base rate.

Should the Feds continue to cut rates, as many investors hope, many people who bought homes during the high-interest rate period will look for better deals.

“The refinancing wave will be huge, but not tomorrow or in the coming months,” said Kamran Ansari, a venture partner at venture capital firm Headline. “It may not be worth it to refinance at half a percent, but if rates drop by one percent or one and a half percent, you’ll see a flood of refinances from everyone who was forced to take the plunge on a mortgage . at the higher rates of the past few years.”

Ansari expects a significant recovery for mortgage fintechs like Rocket Mortage and Better.com after sluggish performance in recent years.

After that, the dollars from venture capital investors will almost certainly flow. Ansari also predicted an increase in the number of new mortgage technology startups as interest rates become more attractive.

“Anytime you see a space that’s been dormant for four or five years, there’s probably opportunity for reinvention and updated algorithms, and now you can do AI-focused adoption,” he said.