In my last post, I made the case that the financial product no one talks about – auto finance – is actually the single largest spend category in financial services for the un- and underbanked. (Read it)

Today’s subprime customers can pay as much as 10 times more to get a car loan, with Buy Here Pay Here lenders charging rates as high as 30% with no underwriting. This industry is not just large and growing, but it’s also ripe for disruption.  In fact, I believe that the next five years will transform auto finance in much the same way that the last five years have transformed payday lending.

Over the last half-decade, payday lending has evolved from a marketplace dominated by legacy, largely brick and mortar payday shops into one that is pioneering lower cost and better structured credit from a new breed of technology and data-driven alternative lenders.

Five years ago, payday was largely the same as it was 20 years ago.  Online payday options at the time looked a lot like their traditional counterparts, neon lights and all.  The high fixed costs from physical locations were simply replaced by high variable cost from lead generation.  And high loss rates both on- and off-line kept costs high. From a consumer perspective, a combination of bad habits, financial desperation and information asymmetry kept people coming back to payday.

While in many ways that consumer premise remains true today, payday itself has evolved to offer many alternatives, new players and significant advances.  Five years ago, there was no LendUp, or ZestFinance, or BillFloat.  Players like Progreso Financiero and Think were still in relative nascency.  While many can (and do) take issue with these players and others, it is undeniable that they represent a vanguard of new and improved solutions.

What’s behind these improvements? Better disclosures have led to better informed buying decisions; use of big-data and better risk scores have resulted in lower losses and better terms; new channels like merchants and mobile phones have both forced and allowed for better economics; and great design has created long term brand loyalty.

Soon, we will see similar technology, data and mobile advancements drive a parallel evolution in the subprime auto industry. While there are very few startups in Silicon Valley today focused on non-prime auto finance (NeoLoan is an exception), we do see compelling startups in the broader auto space (for example: TrueCAR, CoverHound, Tesla, Uber, Lyft and Side-car) and prime-targeting financial institutions like Chase are beginning to explore new finance methods.  This, together with the size and growth of subprime auto finance, paves the way for innovation moving down-market.

For my next post, I’ve got some smok’n auto finance predictions that we’ll put our money on.  Wait for it!