Helping Low-Income Workers Stay Out of Debt
Stagnant wages, a rising cost of living, and increasingly irregular schedules routinely force many working Americans onto a financial knife’s edge; they’re able to pay their usual bills but lack a buffer to handle even small financial shocks. Part of the problem is that most U.S. workers are paid biweekly, and it can take as much as a week for a paycheck to clear, making the wait for compensation even longer. In addition, many workers lack the credit scores to qualify for standard market-rate loans. So to make ends meet or cover unexpected bills, they often rely on payday loans, auto-title loans, and bank overdrafts—high-cost instruments that may push them further toward financial ruin. Economic downturns, such as today’s pandemic-related recession, only increase dependence on these services.
A study conducted at the Harvard Kennedy School explores how innovative fintech products can disrupt this damaging cycle and benefit employees and employers alike. The researchers studied two start-ups that partner with employers to make new financial offerings available as part of employees’ benefits packages. PayActiv advances wages that workers have accrued but haven’t yet received. Sometimes operating in conjunction with payroll companies such as ADP, it serves employees of FedEx, Pizza Hut, and Wendy’s, among others. Salary Finance goes a step further, offering employees low-cost loans that are automatically repaid through paycheck deductions. Based in the UK, it has expanded to the United States, where clients include the United Way and Tesla.
The innovation fueling both business models is the “salary link”—the provider’s ability to directly access wages to ensure repayment of advances or loans. PayActiv applies algorithms to time and attendance data supplied by the employer, adjusting for schedules, tips, and so on, to accurately determine how much an employee has earned at any given point between paychecks. “PayActiv essentially takes on zero risk, as it’s only advancing earned wages,” says Todd Baker, one of the study’s coauthors and now a senior fellow at Columbia’s business and law schools. The firm charges $5 for each pay period in which the service is used (employers often pick up part or all of the fee).
Salary Finance offers loans to partner company employees as long as they are 18 or older, have worked at the company for a year or more, and make at least $10,000 annually. Rather than rigidly applying third-party credit scores, it uses its own estimation of repayment probability to gauge an employee’s ability to afford the requested loan. The interest charged—as of this writing, rates range from 5.9% to 19.9%—does not change if the employee leaves the company; in that case, loan payments are drawn from the borrower’s personal bank account designated during the application process. “Salary Finance’s exposure is dramatically lowered because its automatic deduction turns an employee’s salary into de facto collateral,” Baker says. Indeed, the researchers found that the firm had a default rate just a fifth of that which would be predicted by credit-scoring models.
Do the offerings make a difference to the workers they serve? To find out, Baker and his research partner—Snigdha Kumar, a former Harvard Kennedy School student now working at the fintech start-up Digit—compared the start-ups’ fees with those of market equivalents. Proving PayActiv’s advantage was straightforward; the $5 fee is well below the typical $35 overdraft fee charged by banks and the $30 most payday lenders charge for a two-week $200 loan.
To evaluate Salary Finance’s impact, the researchers first compared the annualized interest rate charged by the firm with those of several personal-loan lenders. Salary Finance’s was considerably lower—it averaged just 11.8%, versus 21.9% to 71% among the conventional lenders assessed. But that’s only half the story, as an analysis of users in the UK showed. The typical Salary Finance loan goes to borrowers with very bad credit (the equivalent of a U.S. FICO score of 480 to 500). Americans with such poor ratings usually don’t qualify for personal loans; they often have to resort to payday-type loans, whose annualized interest rates generally exceed 200%. Salary Finance also reports the payment history on its loans to credit agencies, enabling “credit-damaged or credit-invisible employees [to] use these products not only to access credit but to eventually reenter the mainstream financial world,” Kumar says. “That was our most exciting finding; it’s life-changing.”
Baker and Kumar then set out to determine whether companies also benefited. They hypothesized that the offerings would raise employee productivity, by reducing distractions caused by financial worries, and lower employer costs, by stemming the health care expenses associated with stress-related illnesses. Proving or disproving that turned out to be infeasible with the available data. But an analysis of the employment histories on 1,707 employees at 16 companies that had adopted one or the other of the offerings yielded some interesting findings. For example, in companies partnering with Salary Finance, turnover was 28% lower among active users than an analysis of previous years’ retention data would suggest. As for PayActiv, turnover was 19% lower among active users than among employees who enrolled but used the offering once or not at all.
High turnover is a perennial challenge for many of the large retail companies that employ low-wage workers, so the savings from such boosts in retention could be dramatic. Let’s say a retailer with 340,000 employees has a turnover rate of 50% (a conservative figure; seasonally adjusted turnover rates among U.S. retailers average about 60%). Extrapolating from meta-studies on attrition, the researchers estimated that this would cost the company some $567 million annually. A 28% reduction in turnover could thus save it close to $160 million a year—and “even a 5% reduction in turnover would be worth about $28 million,” Kumar says. To be sure, the analysis found a strong association, rather than causation, between the fintech offerings and heightened retention. It’s possible that the firms had other characteristics that induced employees to stay. Nonetheless, the researchers write, “We believe that there is enough evidence to support rapid implementation of employer-sponsored fintech benefits across corporate America.”
Baker and Kumar anticipate that all pay will one day be instantaneous. Gig-economy companies such as Uber, which offer instant payment to their contractors, are changing workers’ expectations. And the U.S. Federal Reserve seems to be nudging banks to clear funds more rapidly by rolling out an instant payment service of its own, called FedNow. “These fintech tools won’t solve America’s income disparity, but they can help people on the margins who are currently being exploited by the existing financial system,” Baker says. “And it’s in employers’ interests as well—a rare win-win.”
Helping Low-Income Workers Stay Out of Debt
Research & References of Helping Low-Income Workers Stay Out of Debt|A&C Accounting And Tax Services
Source