What is a payday advance?

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Unexpected expenses can leave you stuck if you don’t have the funds available to pay them. Some companies offer …

Unexpected expenses can leave you stuck if you don’t have the funds available to pay them. Some companies offer payday advance services to help employees bridge the financial gap between paychecks and avoid more expensive options. But they are not necessarily a good choice.

Can I get an advance from my employer?

An employer-managed payday advance is when a business, directly or through a third party, allows you to get a portion of your next payday or even a week or so in advance.

Traditionally, payday advances have been a rare request from employees. But the digitalization of the payroll process has made it easier for a business to make money available when employees need it.

Employees would most likely use this service if they had a bill to pay or last-minute expenses, says Bill McCracken, president of Phoenix Synergistics, a marketing research firm that serves the financial services industry.

“For an employer to make part of a paycheck available to pay that bill, I think that’s positive,” McCracken said.

A common type of payday advance not tied to your employer is a payday loan or a cash advance, which is offered through a bank or credit union, such as a check cashing service. These types of short term loans provide immediate cash, but can be very expensive for borrowers.

“What really differentiates this product from a payday loan is the fact that it’s tied to the employer,” says Glen Sarvady, senior director of 154 Advisors and a payments expert working with credit unions, banks and fintech companies.

How does a payroll advance work?

With an employer-led payday advance system, employers partner with a third party – often a fintech – to offer payday advances as a benefit to employees, giving them the option of borrowing against the next paycheck. pay.

In recent years, several companies, including Walmart, have entered into partnerships with companies to provide payroll advance services to their workforce.

In the case of Walmart, employees who sign up for the program can get an estimate of hours worked and accrued earnings on a mobile app. Depending on the employer, employees could be charged a small lump sum for each pay period they use the service and receive money sent to a bank account, card or even to pay a bill directly.

Other services available under an employer-led payday advance agreement could include savings options, online bill paying, and financial counseling. Often there are limits on how much an employee can borrow, such as no more than 50% from an upcoming paycheck.

The payday advance fee is usually lower than a payday loan because it is a lower risk for the payday advance partner company.

“They know the next paycheck is coming,” says Sarvady.

[Read: Best Personal Loans.]

Why is the payday advance necessary?

With many Americans living paycheck to paycheck – up to 78% of working Americans, according to one 2017 CareerBuilder Survey – a benefit like the payday advance could help cover emergency expenses. Also, according to the Charles Schwab Modern Wealth Survey 2019, only 38% have built a emergency fund.

The situation worsens at lower income levels. It is more difficult for low-wage workers to manage emergency expenses without taking out a payday loan or triggering a overdraft on a bank account.

An employer offering a payday advance can “sort out a little bit of the cash flow crunch that is part of everyday life” for low-income workers, McCracken says.

For someone who doesn’t have a lot of cash on hand, getting the cash right away is vital, as they may have bills to pay before 5 p.m. that day, he adds.

A payday advance system is also useful for people with inconsistent wages and hours, such as restaurant workers or carpool drivers.

“I think there’s a natural correlation with the gig economy,” says Sarvady.

Providing a service such as payday advance can also help limit employee turnover and relieve daily financial stress for employees.

What are the potential pitfalls of the payday advance?

As with any service that lets you borrow money, there are potential drawbacks, especially for employees who continually take payday advances.

“They can play a role in helping people cope with occasional expenses,” says Lauren Saunders, associate director of the National Consumer Law Center, which works on consumer-focused issues for low-income and other disadvantaged people. . “My concern is that they can easily lead to chronic use similar to payday loans. ”

For example, if someone is continually receiving payday advances, it can be “kind of a sugar rush,” says Sarvady. “It’s only as good as people being fiscally disciplined.”

For employees, it’s important to make sure the payroll advance service is linked to your employer and their payroll system, McCracken says.

“The so-called early access apps that are offered directly to consumers are just a payday loan,” says Saunders. “They have no connection with real wages.”

[Read: Best Debt Consolidation Loans.]

How to Avoid Payroll Advance Problems

Before taking out a payday advance, think about the long-term consequences. Ask yourself these questions to determine if you can handle this quick money option.

Is there a limit on the amount of the advances? “There should be a limit to how much you can advance because you don’t want a situation where you can advance 100% of your check” because you still have regular and outstanding bills to pay with every paycheck, McCracken said.

“If you couldn’t afford $ 300 on that paycheck, why can you afford it on the next paycheck?” Saunders said.

What are the fees? “The fees and interest rate should be reasonable for this type of product,” says McCracken. An employee can compare these costs to payday loan rates – where the annual percentage rate can reach 400% – as well as overdraft fees for banks, which average around $ 30.

Is there a limit to the number of times you can get a cash advance? If there are too many advances, it defeats the purpose and you “put the employee in a loan cycle where they have nothing on their pay,” McCracken says.

Some employers offer financial education through the third party payday advance company. But it’s better for employers to structure the product so that it’s safe rather than offering a product that lets people fall behind their pay, says Saunders.

Ultimately, the payday advance is a loan, “but you borrow from yourself,” McCracken says. “The company has every interest in making sure the employee doesn’t get carried away.

How is the payday advance different from check cashing services?

An employer-run payday advance program is different from a payday loan primarily because it is tied to the employee’s payroll, rather than being a transaction with a company that is not. not linked to the employer.

There are also differences in the method of borrowing and the cost.

With a typical payday loan, you establish a loan agreement with the lender for the amount you wish to borrow; States often limit the amount to no more than $ 500. Once you get paid, the lender must be repaid the amount you borrowed, plus fees. If you can’t pay off the loan in two or four weeks – the most common loan periods – the charges continue every two or four weeks until the loan is paid off.

Payday loan fees can be high; if someone takes out a $ 100 loan with two week repayment, a $ 15 fee could equal an APR of around 400%. The maximum APR credit card, for example, is generally about 30%.

Also, since your employer is not involved in the transaction, they cannot limit the number of times you borrow against your future income, as may be the case in an employer-led program.

[Read: Best Home Equity Loans.]

What is the future of the payday advance?

It is possible that in the future, many companies will allow their employees to collect their wages more quickly on a regular or even daily basis.

The traditional model of two paychecks per month “has been in place for decades now,” in large part because of the administrative burden for businesses to process, print and distribute paper checks, says Sarvady. As a result, people earn most of the salary before they get it.

“The question arises: ‘If I have already won the money, why do I have to wait for it?’ Says Sarvady.

Some companies are already working with employers on business models that allow daily access to earned wages at a cost per transaction for employees, or at a rate determined by employees who choose one of the many time options at no cost to them. .

A daily payroll scenario can “go through a normal payroll process,” says Caton Hanson, co-founder and general counsel of Nav, which helps business owners manage credit. “It’s not necessarily a lead. You earned that salary today. Here is.”

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What is a payday advance? originally appeared on usnews.com

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