The idea that workers live from paycheck to paycheck may be shocking. And that they often pay to access their own wages. Shocked or not, it's the new reality. Payday loans and cash advance apps are a painful — and costly — path for many. But there's a better way for both employers and workers.
In a recent LendingClub report, 62 percent of adults say they're living "paycheck to paycheck," making them exceptionally vulnerable to unbudgeted items or general price sensitivity. These earners are often only one flat tire or one emergency room visit away from financial catastrophe.
A common solution is to put more charges on credit cards, and many follow this route, as Americans now have over $1 Trillion in credit card debt (which works out to an average of $5,910 per person). And we know that debt comes at a price — credit cards now can charge upwards of an astounding 20 percent in interest. That $100 car battery just cost you $120.
They call it a mountain of debt for a reason. Perhaps more apt is an avalanche of debt. Climbing out from under that weight is difficult, if not close to impossible.
Current alternatives: Payday loans and apps
The options for those who need access to their pay before it's traditionally issued are plentiful, but they exacerbate the problem by applying high rates for what are essentially short-term loans. These payday loan providers charge an astoundingly high rate. For the average two week payday loan, interest rates range from 390 - 780 percent, and finance charges rack up another $15-30. When the paycheck arrives, a significant portion goes to paying off the loan, and more to satisfy the interest and fees, which may cause a repeating pattern. Many who participate in this system find themselves unable to climb to safety, paycheck after paycheck. According to the Federal Reserve Bank of St Louis, approximately 91 percent of borrowers are unable to repay their payday loans at the end of a term. And, approximately 99 percent of payday loans go to repeat borrowers. The report goes on to say, "government reports conclude that the industry relies on repeat (rollover) borrowers." Once started, the cycle is difficult to break.
Direct-to-consumer apps like DailyPay, EarnIn, and MoneyLion allow users to borrow against their expected next paycheck. These cash advance apps function similarly to the payday loan providers with often equally high rates and fees. And some programs are repaid by directly debiting worker's bank accounts, raising the risk of overdraft fees (National Consumer Law Center).
“The biggest problem with these programs is they really end up with people paying to be paid, and that’s just wrong.”
Lauren Saunders, National Consumer Law Center
What role do employers currently play?
Employers such as Uber, McDonald’s, Burger King, Domino’s, and Chili’s have introduced earned wage access programs in some form. And others may offer to cover the cost of early wage access via a cash advance app. Recognizing the critical nature of employee retention, especially for those in lower wage roles, employers are adding options to paydays, but these can carry a price tag. Employer-based programs generally charge fees of a few dollars per transaction, depending on the amount of money that’s requested, while cash advance app fees can range from less than a dollar to over $20. Many of these apps disguise additional fees by having users add a "tip," with users often unable to figure out how to avoid the additional charge. While the percentages may be smaller, frequency can make the costs add up.
Once started, users become accustomed to having immediate access to funds, applying them to more everyday expenses, vs. only for unexpected or emergency spend. A Harvard study found that "only a quarter of respondents used direct-to-consumer early wage access apps to cover emergencies or unexpected expenses, while three-quarters rely on such services to pay for regular expenses like groceries, rent, gas, and childcare." A new cycle begins, at a lower cost, but is likely to persist in reducing take-home pay with every paycheck.
Giving access to pay without additional cost
Retaining a vibrant workforce has never been more important, and early access to wages can be a powerful lever, as employees look not only to how much they get paid, but when. Adding flexibility to the payroll portfolio gives companies a hiring advantage and can be the reason good employees stay.
Employers can offer embedded finance capabilities like bank accounts and open-loop debit cards, giving their workforce more options to get paid, even those without traditional bank accounts. An embedded account operates much like a traditional account, with full ACH capabilities and routing numbers. Payroll is deposited directly, and companies can offer immediate access to earned wages, sidestepping the pre-funding necessary with payroll providers. For the employee, wages are immediately accessed and controlled by the employee without interest or fees. For the company, payroll funds can be released just-in-time (JIT) without bank fees or latency.
Companies can also issue payments to workers via open-loop, pre-funded debit cards. Employees can get the pay they've earned with an opportunity to spend where they want without risk of credit card debt. Funding for these physical or virtual cards is the same for the company, and payroll is routed through company-owned accounts and cards.
Workers shouldn't have to pay to access their pay
An entire industry has been built on the need for workers to access their pay on their terms. Unfortunately, while payday loans and cash advances serve a large portion of workers, they come at a high cost, and encourages a repeat pattern of borrow, pay, borrow again. Effective wages and spending power take the ultimate hit.
Employers can own the process, and remove barriers to earned wages by leveraging embedded finance. Taking control of the employee experience and offering access to earned wages at no cost will reap rewards in a more dedicated workforce and more fundamentally sound financial decisions.
More? Read our article on workforce retention in Chief Executive
