Financial shocks harm both workers and their employers. They not only affect workers’ well-being but also potentially undermine their employment and prospects for labor market mobility. Employers bear costs if employees are less productive or absent because of financial stress or if employees resort to retirement account withdrawals or are subject to wage garnishment after taking on high-cost debt.
Employers are increasingly recognizing the need to support workers’ financial health through benefit programs that include financial coaching and education as well as products and services, including small-dollar loans. Particularly for workers with limited access to credit, employer-sponsored small-dollar loans (ESSDLs) are an affordable alternative to more expensive forms of credit, such as payday loans, borrowing or taking withdrawals from retirement accounts, or subprime credit cards. Because ESSDLs are a relatively new financial product, evidence on their effectiveness is limited. A 2010 Federal Deposit Insurance Corporation pilot study identified partnerships with employers as a promising strategy (PDF) for expanding small-dollar loan availability.
A recent Urban Institute examination of ESSDL products, lenders, and employers who offer them expands knowledge on a potentially scalable solution for improving financial outcomes for workers with limited credit access. The research team interviewed and reviewed products from 10 ESSDL providers and examined employer perceptions of ESSDLs gleaned from interviews and research. Here are four takeaways from the study:
A variety of financial institutions offer ESSDLs
The 10 lenders whose products the authors examined represent a variety of financial institutional types: banks, credit unions, community development corporations, and consumer finance companies. The loan products varied by their terms, annual percentage rate or interest rate, employer and employee fees, and other program features. Lenders also differed in how they delivered loans to borrowers, with several using financial technology platforms and others with a retail presence serving employers and workers in a specific geographic area.
Several local and regional institutions offered the loans as part of a more comprehensive employee financial wellness program that included other services, including financial education, coaching, and referrals to other community resources. All lenders used the borrower’s status as an employee “in good standing” as underwriting criterion, and the majority did not require credit checks when determining loan terms.
ESSDL products have safeguards in place to protect borrowers’ financial health
ESSDLs are considered a safer alternative to higher-cost forms of credit because they have certain built-in safeguards. All products reviewed in the survey had interest rates and fees below the 36 percent interest rate cap endorsed by many consumer advocates (PDF). All surveyed lenders used payroll deductions for borrowers to repay loans, reducing the risk of late payments or loan defaults. Lenders also created loan parameters designed to help borrowers avoid additional debt, such as limiting borrowers to one loan at a time and limiting the loan amount to a percentage of the borrower’s paycheck. Even with these built-in safeguards, ESSDLs have low barriers to access and high approval rates to help employees avoid more onerous forms of credit.
ESSDL loan programs offered additional benefits to borrowers beyond the loan itself
Several lenders linked ESSDLs to an automatic savings program that allowed borrowers to build emergency cash reserves. Certain lenders continue payroll deductions after the loans are repaid and convert them to savings. All interviewed lenders reported payments to at least one credit reporting agency, enabling borrowers to establish or improve their credit scores and helping them gain access to credit on more favorable terms. Nearly all the lenders also offered either financial counseling or financial education—services associated with positive financial outcomes, such as fewer defaults, higher credit scores, and reduced use of payday loans.
Employers perceive ESSDLs as mutually beneficial to themselves and employees
Employers interviewed by the authors said their decision to offer an ESSDL benefit was based on concerns about employees accessing high-cost payday loans to cover emergency expenses. They valued ESSDLs as a safe, affordable, and convenient alternative to payday and other nonbank loans. ESSDLs also reduced financial risks to employers who previously provided ad hoc loans or payroll advances to workers. Several employers anecdotally mentioned a decline in employee withdrawals from retirement accounts, which also led to lower administrative costs for employers. Of the ESSDL products examined in the survey, employer fees and administrative costs were minimal. Employers also spoke favorably of ESSDL programs allowing un- or underbanked workers to establish or improve credit and build savings and relationships with financial institutions.
Questions for future research
Although ESSDLs show promise as a tool to help low- and middle-income workers stabilize their finances and as a financial wellness benefit that lowers employer costs, more evidence is needed on whether these loans improve workers’ financial well-being, how workers utilize these loans, which barriers or incentives affect employer participation in ESSDL programs, and how these programs affect employers’ bottom lines. Additional research on ESSDLs and their specific features will enhance understanding of how access to affordable credit can shape worker outcomes.