Can FinTech Change Payday Lending?
For most people in the payments industry, when you're strapped for cash and an unforeseen emergency occurs, you dip into savings or pull out your credit card. You get quick access to funds and take care of the task at hand. But if you don't have enough in savings or a credit card, it's not that easy. For millions of Americans living paycheck to paycheck they need a solution that gets them cash now to make ends meet.
This is where payday loans come in. A payday loan is a loan that requires the borrower to write a post-dated check for the amount to be borrowed, plus a finance charge. The lender then gives the borrower the money, and when the borrower gets paid, the check is cashed. There is no credit check, and the only requirements are an active checking account and a regular source of income. It is a life line to many and when used properly, payday loans address a need that banks and credit unions cannot or will not.
However there are some significant issues with payday loans that consumer groups and regulators highlight:
Payday loan companies charge insane amounts of interest. The loans they make have an average APR of 400%, but some charge as much as 5,000% interest. And you though interest was high on credit cards! To be fair APR is not an effective way of evaluating the fees and interest given the short terms of the loans. And even though linked to a check, the loans are riskier than traditional loans so the interest rate will naturally be higher to cover losses.
When a borrower can't afford to repay the loan on their next payday, they must notify the lender right away so that the check will not be cashed. If they fail to do so and the check bounces, they could be charged fees by both your bank and the payday lender.
If a borrower must extend a payday loan, they'll have to write another post-dated check and pay another finance charge. This can turn into a vicious cycle, and they could end up paying more in interest than they actually borrowed. This is the concern that financial health advocates point to as the primary danger of payday loans. It is a very real concern and many states have introduced a “cool down” period to limit this cycle.
Because of the high interest, payday loans are illegal in some states. Other states allow them, but due to strict regulations, payday lenders may choose not to operate in some of these states.
When Should a Customer Get a Payday Loan?
If possible, it is best to avoid payday loans altogether. If someone can borrow money from a friend or relative or postpone the expense until after they get paid, they'll be much better off. But there are certain situations in which a payday loan can be helpful.
Some people take out payday loans to get their cars repaired. If it's an urgent repair and they need the car to get to work, it's probably better to go ahead with the payday loan if there is no other alternative.
Or if they need to see a doctor and do not have insurance, a payday loan could get you the medical care they need.
But if the situation is not an emergency like these, there are probably alternatives that are not as expensive or risky.
FinTech to the Rescue
As you read this article, you may have noticed a common theme. A customer has a financial requirement, they need to access funds that they have earned and the next payday is in the future. So they right a check in order to take an advance on their earnings and pay significant fees to do so. Why? Because our payroll system is built on a concept of weekly, bi weekly and monthly payment. The legacy systems are not able to get paychecks/ direct deposits out any faster and that means employees can’t access their earnings when they need them.
However, there are several innovative companies that are addressing that issue. They allow an employee to access up to 50% of their earnings and move them into a checking account, debit card or as cash. All for a flat fee that is much lower than a payday loan. And in some cases, the employer will cover the cost so it is a free service to the employee. PayActiv, Instant and FlexWage all have slightly different takes on the concept. But each provides a solution that allows an employee to get real-time access to earned but unpaid wages with zero debt. They typically require no or limited integration for the employer and can be launched in a matter of days.
Some of the employee benefits include
Instant access to wages
Eliminate the need for payday loans
No overdraft fees.
Savings and budgeting tools
Mobile access for complete control and flexibility
As these programs become more widespread, it could mean the end of the payday loan industry.
New alternatives are coming, but for now many will still turn to a payday advance. Before someone gets a payday loan, it's important to consider all of their alternatives. If the expense can wait, or if they can get the money some other way, they're better off leaving payday loans alone. They should check with their employer and see if they offer access to earned wages through a company like PayActiv, Instant or FlexWage. (if not ask them to add one) And if they do end up getting a payday loan, it's important to pay it off as quickly as possible. If they don't, it could get them in more financial trouble than they're already in.