Are Salary Advance Companies All They're Cracked Up To Be?
After the well-publicised collapse of Wonga and other payday lenders a new type of product has emerged to fill the gap left in the market. Wagestream, Hastee Pay, and Salary Finance are just 3 of the companies that have sprung up in recent times offering a way for employees to access their salaries before they get paid. They’re not offering payday loans with extortionate interest rates but an alternative which they say is fairer and will help people manage their money better.
Whether they are called salary advance or earnings on demand, the value proposition is the same.
The majority of employees get paid in arrears. This means that even though you have worked for 2 or 3 weeks of a month, you have to wait until the end of the month before you get paid. And people who struggle to manage their money until the end of the month may have to resort to taking out a short-term loan, usually called a payday loan. The idea with a salary advance solution is that if people can access their earnings earlier, they will not have to rely on payday loans to see the month out.
A fairer way of lending
An alternative to payday loans on paper sounds great. I’ve seen HR Directors nod their heads in approval when salary advance is sold in to them as they see the end of spiralling debt and all the stresses that can have on employees’ lives which affect their productivity at work.
But it helps to know a bit about the history of payday loans to understand the concept of salary advance.
Payday loans came into existence back in the day when workers were given their monthly salary in the form of a cheque. The cheque would normally need to be cashed at a bank and would take a few days to clear. You could easily wait a week to actually get hold of the money. As a result, short term cash advances and “payday” lending were made available from high-street businesses like Cash Converters and The Money Shop who used the employee’s pay cheque as collateral for the loan. This model morphed into the payday loan model we are more familiar with as companies realised they could lend on future pay earlier and earlier with higher and higher interest rates.
So how is a salary advance different from a payday loan? Salary advance products claim that they aren’t loans because they don’t charge interest and there are no hidden fees. Instead they take a small fixed fee from your pay cheque along with the amount withdrawn. Because these companies tend to manage everything through apps their overheads are lower than traditional cash advance companies, so their fees are lower. They are also able to skirt around the lending laws, so, for example, they do not perform any credit checks.
However, I would argue that a salary advance product is still a loan. You are still borrowing money that needs to be paid back and although there is no interest rate associated with them you still have to pay back more than you borrowed because of the transaction fees.
Encouraging bad habits
My next concern with salary advance products is that they are advertised as though they will help improve your financial and overall happiness. Buy that dress you’ve got your eye on before it sells out in your size. Need to replace your washing machine? Just access your salary now and you don’t need to struggle relying on hand-washing, laundrettes, or mum for the rest of the month.
In this article I talk about the importance of building an emergency fund. These are savings that sit in a bank account that you can access in an emergency such as replacing your broken-down washing machine or fixing your broken-down car. You should also build up savings over a year so you can pay for things like Christmas presents or holidays.
Your emergency fund is the first step towards saving larger amounts. Keep increasing your pot and eventually you will have enough to pay for a new car or even buy a house. But it all starts with your emergency fund.
Salary advance acts as the anti-emergency fund. It encourages people not to have emergency savings as there is always the option of taking some money from your salary before you get paid. As people become reliant on this, their incentive to save diminishes.
If these companies really cared about helping people improve their financial wellbeing employees should take out a salary advance once and then never have the need for it again.
So I’m baffled why these businesses are not only thriving but also getting investment. Except of course that however they dress it up they really are payday lenders and customers will eventually become trapped on relying on them every month.
Let’s take a look at the fees they’re charging. One of the market leaders charges a flat £.2.99 transaction fee. If you take an advance of £100 this works out at an APR of 43%. It may not compare with the APRs over 1000% that some of the payday lenders were charging but it’s still very high. Of course if you take more of your salary then the equivalent APR will be lower. But then next month you’re going to have significantly less money in your pay packet. Can you guarantee that you won’t need to rely on salary advance again to get you through the month?
One of the lines of defence I have heard used by these salary advance companies is that you can squirrel the money away into a saving account. But this makes no sense when you consider the fees charged on salary advance, and the interest rates on savings accounts which is next to nothing these days.
Relying on salary advance may also mean you find it difficult to leave your employer as you will always be behind on your budget.
I think it is important to help people understand why they get pad in arrears which essentially means that companies hold onto cash that you have earned.
Waiting a month to be paid is not ideal but remember a business is performing a lot of processes to generate revenue. It needs to pay rent on an office or factory. It needs to buy raw materials and process them. It needs to sell products and wait to get paid by consumers and other businesses. This is not instant so the time taken for companies to earn money from employee input is not instant either.
Broadly, this is part of a process referred to as days working capital and this is why companies need working capital. Deferring your salary to the end of the month is an indirect form of working capital and without it companies would struggle to exist because they would be paying out too much money before they have been paid by their customers.
As employees we might want to fight this by getting paid instantly. But the natural reaction from employers would be that the cost of employment has gone up so each employee would need to be paid less. Or you could end up with a two-tier system where employees willing to accept month-end salaries earn higher salaries than instant-salary employees.
Even if you argue that salary advance businesses are supplying a new type of working capital, there is a cost involved. And employees are paying for it. If you are an employee, the question you need to ask yourself is; would instant salaries make running a business harder and therefore would you simply prefer to be paid more?
We believe that the majority of people would just want to be paid more. So instead of accepting salary advance as an employee benefit it would be better to seek a higher salary. This might be achieved through membership of a union, by collective bargaining, by salary transparency, or by finding a different job.