Early Access to Earned Wages vs. Payday Lending

With the rise of peer-to-peer payment applications and other new technologies, people increasingly are expecting faster payments, including workers who want greater flexibility than the traditional two-week pay cycle.

It is welcome news that technology and emerging services allow workers to access part of their earnings before payday. However, some service offerings have raised concerns about what is allowed, especially for providers with no connection to an employer to directly verify available earnings.

An investigation into payroll-advance companies was announced Aug. 6 by the New York Department of Financial Services. Joining New York in the investigation are banking regulators from Connecticut, Illinois, Maryland, New Jersey, North Carolina, North Dakota, Oklahoma, South Carolina, South Dakota, Texas, and Puerto Rico. The investigation is to focus on whether companies are in violation of state banking laws, including usury limits, licensing laws, and other applicable laws regulating payday lending and consumer-protection laws, the department said in a news release.

The investigation highlights critical differences between payday-lending practices that can put individuals in an endless cycle of debt and emerging financial technology companies that offer a responsible alternative for managing unanticipated expenses that occur between paydays, such as auto repairs or medical emergencies, at a fraction of the cost of a payday loan or bank overdraft fee.

The need for early access to earnings is not new. Recent surveys confirmed that nearly 80% of workers live paycheck to paycheck, with little savings available for emergencies. Many businesses have for decades accommodated occasional employee requests for pay advances. But if an employer was unwilling to advance wages, workers were left with few options, such as choosing between high-cost payday loans or failing to meet financial obligations and incurring fees from late payments or bank overdrafts.

Workers who choose a payday loan also risk falling deeper into debt. For example, workers in California can obtain payday loans up to $300, regardless of whether the cost of the loan is affordable, based on their income and expenses. Borrowers typically receive $255 after paying a fee of up to $45 and are obligated to repay the loan in 31 days. Repayment often leaves the borrower short of funds the next month and again in need of a loan to cover expenses. Such situations can create an ongoing cycle of costly payday loans.

Connecting With Employers

Financial technology companies with a connection to an employer’s payroll system make it possible for workers to access money they have earned before the next payday. The services are offered without the high costs and risks associated with payday loans, and regardless of an employer’s willingness to offer pay advances.

Regulators also may look to factors such as credit applications and whether an advance is based on verified earnings. Unlike payday lending, most early wage access firms do not require a credit application because the funds already represent the employee’s earned wages. Some firms merely rely on consumer confirmation or evidence of employment, such as a recent pay stub, instead of direct verification of available earnings through the employer’s payroll system.

Early wage access firms also do not charge interest. Instead, there may be a small charge for each transaction, similar to an ATM fee (i.e., often less than $3). Other providers charge a flat membership fee that allows several early wage accesses over some period of time. In either case, employers do not have to modify payroll schedules or processing, which minimizes involvement.

A research paper by Harvard’s Kennedy School, published in May 2018, studied the early wage access industry and noted that offerings “are more efficient than market alternatives and provide clear and compelling benefits to employees … one-seventh of the typical $35 per overdraft fee charged by banks … 16.7% of the cost a payday loan, for which lenders typically charge $15 per $100 borrowed.” The study also highlighted greater inclusivity, such as employees who are “credit-damaged or credit-invisible—who could not access traditional financial products in the market.” As the research paper noted, the direct connection to payroll is what makes the systems efficient.

Not surprisingly, several national employers are working with such service providers, offering early wage access with full disclosure and voluntary consent. The employers recognize that early wage access alternatives can be a major improvement for consumers, especially compared with the alternatives of payday loans, bank overdraft fees, or other high-cost short-term solutions. To help ensure a responsible alternative for workers, some providers have sought input from consumer advocates and adopted safeguards, such as limiting access to a percentage of available earnings and the frequency of such access.

Small Steps, Potential for Big Gains

Understandably, regulatory review of any new practices involving wage-payment laws can take time and raise uncertainty. When payroll direct deposit was first offered in the 1980s, many state regulators raised concerns because direct deposit was not a recognized method for wage payments under laws that were written in the 1940s. Direct deposit is simply the electronic payment of payroll into employees’ bank accounts, which made time-consuming trips to the bank a thing of the past. In retrospect, direct deposit was a substantial improvement, yet the regulatory and legislative debates were hotly contested, spanning more than 10 years.

In California, providers of early wage access are working with state lawmakers on legislation that would codify and recognize such providers and establish consumer safeguards, such as fee restrictions, limits on the number of accesses and percentage of gross pay to be advanced, and related disclosures. While legislation may not be necessary, it may help clarify the regulatory treatment of these services. The California bill may become a model for other states.

State regulators are to be commended for reviewing whether any practices of early wage access service providers rise to the level of predatory payday lending. The investigation by the New York Department of Financial Services and the potential legislation in California may serve to clarify permissible practices. This may also distinguish between providers that offer early access to earnings through a connection to employer payroll systems with responsible consumer safeguards, and alternatives that may subject workers to debt risks similar to payday lending.

With proper recognition of these distinctions by regulators and legislators, the long wait for the next payday may also become a thing of the past.

By Pete Isberg

Pete Isberg is president of the National Payroll Reporting Consortium, which represents a group of payroll service providers. He also is vice president for government affairs with ADP LLC.