A better alternative to payday loans

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More than 50 million Americans from working low-income families struggle to manage their daily cash flow. This means they have the resources to pay their monthly bills, but can’t handle small financial shocks or time lags because they don’t have the savings buffer that the wealthier take for granted. Most do not have access to affordable credit and cannot increase medical, housing and car expenses over time. The result is a damaging cycle of dependence on high cost payday loans, auto title loans and bank overdrafts that often leads to financial ruin. As interest groups argue over whether more or less regulation is the solution, people are hurting.

There is a solution with benefits for employers and employees. In a new working paper released by Harvard’s Mossavar-Rahmani Center for Business and Government, we show that employer-sponsored mobile and online financial products can cover a wider range of borrowers and charge them less money. than those available on the market. Using these FinTech products can also dramatically reduce employee turnover and save employers millions. The key to their success is the “salary tie”, which means that the money provided to employees is automatically refunded through payroll deduction. Large employers can offer these benefits today without changing the law or government intervention.

Our article looked at two employer-sponsored FinTech products: a short-term installment loan from SalaryFinance and an “early access to salary product” provided by PayActiv. The SalaryFinance online loan is available to employees in the UK (and from next month in the US) at a fraction of the cost of competing market products. The difference in cost is greater for borrowers with poor credit.

The typical SalaryFinance loan, given to a borrower with an American FICO score of 480 to 500, carries an annualized interest rate of 11.8%. A borrower with such a low credit rating would not qualify for a standard loan in the US market at any cost and would be forced to look for a payday loan or bank overdraft at over 200% interest. . An employer who offers SalaryFinance can be sure that they are offering much lower borrowing costs and greater access to credit to their employees.


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The same goes for PayActiv, which allows employees to access earned but unpaid wages through a mobile app before their regular pay. PayActiv costs the employee $ 5 for each month the product is used (although employers frequently subsidize some or all of the fees). Meanwhile, the typical overdraft or payday loan costs around $ 35. And PayActiv is available to all employees, regardless of their credit history.

These considerably lower rates are possible because the reimbursement comes directly from the employee’s paycheck. For PayActiv, this almost eliminates the risk.

For SalaryFinance, the link to payroll provides better information on employment status than the credit bureaus used by market lenders. The automatic deduction turns the employee’s salary into a de facto guarantee; SalaryFinance is always reimbursed if the employee remains employed in the same company. And many employees who would otherwise default decide not to quit a job that earns them eight to nine times the value of their loan. These factors lead to significantly better loan performance, with default rates below 20% of the rate predicted by the credit rating.

Our preliminary research also found that these employer-sponsored financial products can improve employee retention, with annual turnover rates 19% to 28% lower among PayActiv or SalaryFinance users. While more research is needed to fully establish a causal relationship, these findings have important implications for businesses. We estimate turnover costs at Target,

for example, are about $ 567 million per year, or $ 3,300 each time a retail employee leaves the company (half each year). Even a 5% reduction in revenue is worth around $ 28 million for a company like Target, and a total reduction of 28% would be worth almost $ 160 million per year. It would be a gold mine for shareholders.

An encouraging sign is that Walmart,

one of the largest employers of low-wage workers, recently made PayActiv available to its employees. From December to March, 80,000 Walmart employees received more than $ 30 million through PayActiv.

It’s time for more American employers to help low-wage workers cope with liquidity and credit issues. There is no excuse to wait for the availability of products that will save workers and their bosses money.

Mr. Baker is a senior fellow at the Mossavar-Rahmani Center for Business and Government at Harvard Kennedy School. Ms. Kumar holds an MA in Public Policy from Harvard Kennedy School in 2018 and a former intern at PayActiv. This editorial is based on their recent discussion paper.

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