How small-dollar loan programs can be a big benefit for employees (and their employers)
By providing their workers with access to affordable, low-risk credit, companies could help ease personal financial stresses—and improve their own bottom lines.
Published June 19, 2018
Financial counseling is one of the many services provided by Minnesota’s largest nonprofit, Lutheran Social Service (LSS), so the organization’s own human resources (HR) staff members are always on the lookout for ways to support their own employees’ financial capacity. When they heard about TrueConnect, a program enabling employers to offer quick access to credit to their employees, a light bulb went on.
“We know from our financial counseling work in the community that there’s this need for access to credit. TrueConnect was a way we could start to fill that gap for our own employees,” said Kristine Thell, accounting manager at LSS.
TrueConnect allows LSS employees to take out loans of $1,000–$3,000 that have an APR1 of 24.99 percent and a repayment period of one year. The loans are funded by St. Paul-based Sunrise Banks and do not carry any financial risk to the employer. Qualifying for a TrueConnect loan is simple. Credit score requirements, which can be a huge financial barrier for people with less-than-stellar credit histories, aren’t applied; instead, employees automatically qualify after working for their employer for a specified period of time. At LSS, the requirement is six months. Repayments on the loan are capped at 8 percent of the employee’s paycheck; thus, an employee’s maximum repayment capacity determines the maximum loan amount. And the program offers every TrueConnect borrower six free financial sessions—a feature that could complement the financial wellness benefits employers provide.
While some staff time was required to set up the interface with TrueConnect, LSS pays nothing to offer the service to its employees, who range from personal care attendants paid by the hour to case managers and executives earning higher salaries.
The organization’s clients include adoptive parents, refugees, foster children, and people with disabilities. Good relationships with these clients are critical to the success of LSS’s mission. And to form and maintain good relationships, the organization needs employees to stick around.
Thell is optimistic about TrueConnect’s potential to improve worker retention, both because of its value as an employer-provided benefit and for its potential to help employees achieve financial stability. “We’re definitely tracking it,” said Thell. “It’s too early yet to tell, but we’re hopeful.”
Over three and a half years of LSS offering TrueConnect, 377 employees have used the program to take out a total of 786 loans averaging about $1,350 apiece. The average borrower earns about $35,000 per year, but the nonprofit’s higher-paid staff also take advantage of the benefit.
“We expected a lot of our hourly, lower-paid employees to use TrueConnect,” said Thell. “But we were surprised to find that about 1 in 4 borrowers earns more than $40,000, and a significant share of our loans were taken out by people earning more than $55,000 per year.”
Credit needs from tellers to the C-suite
LSS is not the first institution to be surprised by TrueConnect’s usage among employees at every level. When Sunrise Banks began its partnership with Employee Loan Solutions, LLC, the California-based creators of TrueConnect, in 2013, it learned something similar about its own workforce.
“Federal regulators were excited about the program’s potential, but they also had some concerns,” said Jamie Nabozny, the vice president at Sunrise Banks currently responsible for administering the bank’s TrueConnect program. “They asked us to pilot the program with our own employees. We were happy to, but didn’t expect to see much usage by our staff. We assumed bank workers would have access to other options.”
It appears that assumption was wrong. By the end of Sunrise’s pilot period, more than 20 percent of its employees had made use of the product—and those employees came from every level of the organization. While the average income of a TrueConnect user at Sunrise was around $40,000, employees earning six figures also took advantage of the quick and easy source of credit.
Sunrise’s willingness to work out the kinks with its own employees was indicative of its value as a partner, said Doug Farry, one of the creators of TrueConnect at Employee Loan Solutions.
“We knew they processed tax refunds for the IRS, so they have a national reach and a technical capacity,” said Farry. “But they’re also a community development financial institution2 with a history of innovation, so they understand the need for a product like TrueConnect.”
Yet even with that background, TrueConnect’s administrators at Sunrise were surprised by their employees’ usage.
“The story we saw in our bank and at Lutheran Social Service is replicated at a lot of the employers we work with,” said Nabozny. “And a lack of awareness about the credit needs of everyday Americans is one of the biggest barriers we face to making this tool more widely available.”
Dire needs and risky options
Some recent analyses of household financial health in the U.S. make a strong case that Americans need frequent access to new sources of short-term credit. In its 2016 Survey of Household Economics and Decisionmaking, the Federal Reserve Board found that nearly a quarter of all Americans cannot pay their monthly bills in full.3 The survey also found that when a household faces a big income drop or unexpected expense, its response will likely depend on its available assets and its access to credit. Forty-four percent of respondents indicated that they would need to borrow funds, sell something, or simply not pay if they faced an unexpected expense of $400. Meanwhile, analysts at the JPMorgan Chase Institute looked at data from a million customers and found that about half see their monthly incomes fluctuate by 30 percent or more over the course of a year.4 Another study found that low- to moderate-income families’ pay dropped by at least 25 percent an average of 2.5 times per year.5
Households that cannot meet routine expenses or cover unexpected ones often turn to credit options that can come with a risk of high costs. Every year, millions of Americans turn to payday or auto-title loans to find credit, collectively spending $9 billion on loan fees.6 Americans also pay $6 billion in costs related to defaults on 401(k) loans.7
A closer look at the role these particular loan products play for American consumers helps explain why a product like TrueConnect may add value for both borrowers and their employers.
Payday and auto-title loans
A payday loan quickly provides a borrower with cash in exchange for repayment out of the borrower’s next paycheck. Auto-title loans operate in a similar fashion to payday loans but use a borrower’s vehicle title as collateral. Typically, a title-loan borrower faces a large balloon payment after one month. Failure to pay may give the lender the ability to repossess the borrower’s car.
Both payday and auto-title loans generally come with an option to renew a loan for an additional fee. The Consumer Financial Protection Bureau (CFPB) found that more than half of all payday loans are renewed at least once, and that about 80 percent of outstanding payday loans are part of a sequence of renewals.8
Renewals carry a whole new round of fees, significantly driving up the cost of the loan. One study found that, on average, a payday borrower takes out $375 and pays $520 in fees over the course of five months.9 Another found that the median payday installment loan, a product paid back over a longer period, was for $1,000 and carried an APR of 249 percent.10 In separate studies, Pew Research and the CFPB found that the average auto-title loan is about $1,000, in exchange for an average of roughly $1,200 in interest and fees.11 With such a high rate of renewals, these loans can potentially turn a short-term cash flow issue into a long-term threat to financial stability.
Many Americans have access to another source of convenient but potentially costly credit: loans from their 401(k) retirement plans. In what’s known as a deferred compensation loan, borrowers take out money from their retirement accounts and must pay it back into the same account, with interest.
Such loans are fairly commonplace among Americans with deferred compensation plans. At any given point, roughly 20 percent of 401(k) users have a loan out from their account; over a five-year period, nearly 40 percent of users have an active loan at some point.12
Calculating the tradeoffs for a 401(k) loan can become complicated in a hurry. For example, if borrowers don’t increase their per-paycheck retirement contributions to account for their loan payments, they will likely see a reduction in their post-retirement income that may outweigh any short-term savings from the cost of credit. And unexpected life events can drive up the cost of 401(k) loans considerably. If a borrower leaves a job and has an outstanding loan, the loan must be repaid within 60 to 90 days. If it isn’t, the borrower is technically in default and must treat the loan as income, paying both income tax and an additional tax penalty on the outstanding debt.
Americans with credit needs defy pigeonholing
A popular narrative about payday, auto-title, and 401(k) loans is that they help their users weather unexpected financial difficulties. However, a survey by Pew Research found that nearly 70 percent of payday borrowers use their loans to cover regular recurring expenses—like rent, groceries, or other debt payments.13 The same was true for 50 percent of auto-title borrowers.14
Data on 401(k) loans is less clear, but large expenses like home purchases or improvements, investments, durable goods, and one-time occasions like weddings or divorces collectively explain less than half of the reasons for obtaining a 401(k) loan.15 And while retirement loans tend to be larger than payday or auto-title loans, 1 out of every 4 is for $2,000 or less, with lower-value loans taken more frequently by lower-income employees.16
Pew Research’s findings about payday borrowers include a summary of borrowers’ demographic and economic characteristics. Borrowers were lower-income, more likely to be unemployed, and less likely to have a four-year degree than Americans on the whole. But 1 in 4 payday borrowers earned more than $40,000, and 45 percent of borrowers had attended at least some college courses—less than the 55 percent of Americans overall, but not dramatically so.17 And, unsurprisingly, lower-income and lower-wealth 401(k) loan users are more likely to default on their 401(k) loans and face high costs than their higher-income, higher-wealth peers.18
Taken together, the data on these loan products tell a story that matches up with research on American households’ credit needs and both Sunrise and LSS’s TrueConnect experiences: while lower-income individuals may be more likely to need quick access to credit, plenty of middle- and higher-income Americans do, too.
A simpler option
Ron Elwood is the supervising attorney of the Legal Services Advocacy Project at Mid-Minnesota Legal Aid, an organization that has advocated for stronger regulation of the payday and auto-title loan industries in the past. His organization’s clients frequently face barriers to credit because they have low credit scores—even though their poor ratings may be through no fault of their own—so he sees a lot of promise in the TrueConnect approach.
Elwood is in favor of TrueConnect despite the product’s 24.99 percent APR. “Lots of consumer groups focus on a 36 percent rate cap for payday loans as their end goal,” he pointed out.
Compared to other quick-access credit options, TrueConnect isn’t just likely to be cheaper: it’s also simpler. No fees are collected from either party and there are no prepayment penalties. The lack of affordable, quick access to credit for many Americans combined with TrueConnect’s low costs and minimal requirements enhance its potential benefits for both employers and employees. But understanding this can often require knowledge beyond one’s personal experience with credit, Elwood says—particularly for higher-paid decision makers.
“Policymakers and CEOs look at the product offered by TrueConnect and they compare it to their own personal credit card or credit lines,” Elwood said. “They don’t realize that those options don’t reflect reality for a whole lot of Americans.”
Nabozny has witnessed that barrier firsthand, but said it isn’t insurmountable.
“I’ve been in meetings where management and employee representatives are asking me lots of hard questions,” Nabozny said. “At some point, it clicks for someone in management, and they say, ‘So, this doesn’t cost us anything, and it helps our employees—isn’t this a win-win?’”
“And I say, ‘We certainly think so.’”
Many low-wage workers have an interest in saving
A developing field of research is revealing ways that employers can support their employees’ financial capacity—and also leading to insights about how a program like TrueConnect can be rolled out successfully in a workplace.
—Jamie Nabozny, Sunrise Banks
Commonwealth is a Boston-based nonprofit that endeavors to understand and find solutions for the needs of financially vulnerable Americans. Its work often includes outreach to employers. Melissa Gopnik, a senior vice president at Commonwealth, said employers sometimes underestimate their capacity to support their workers’ financial lives in ways that go beyond issuing paychecks.
They sometimes underestimate their employees’ interest in developing their financial capacity, too. In a survey of low-wage workers, Commonwealth asked how participants would use a $1-per-hour wage increase. Saving for short- or long-term expenses and paying down existing debt were each selected by roughly a third of respondents. Many surveyed workers also may have lacked a convenient vehicle to save. Only 54 percent of the workers responding to the survey had a savings account, though 4 of every 5 had a checking account.19
Employers can often offer support through products and programs that are already in place. Like TrueConnect, many of the programs promoted by Commonwealth are built around infrastructure that firms may have already developed. For example, many employers offer employees the ability to split their direct deposit between a savings account and a checking account; encouraging some deposit into the latter would capitalize on pre-existing infrastructure, says Gopnik. This capacity could also be used to enroll employees in a program that would automatically deposit any raises into their savings account, or deposit money into a savings account until the account balance reaches a predetermined goal amount.
According to Gopnik, employers have a role to play not just in offering supportive products for their employees: they can also help employees understand their finances by offering planning tools.
“A worker may shrug off a $1 per hour wage increase as insignificant,” said Gopnik. “But when someone shows them that $1 per hour for a 40-hour-per-week worker is actually $2,000 a year, they realize they have a new opportunity.”
Benefits to employers
Roughly 85 percent of workers surveyed by Commonwealth reported feeling like they were “struggling” or “just getting by” financially. Increased financial capacity can help workers feel more secure, said Gopnik, and that translates into gains for employers.
Commonwealth cites studies linking financial stress to reduced employee retention, increased employee absences and turnover, and presenteeism (which occurs when workers show up to work, but are too distracted to maximize their productivity).
As Sunrise’s Nabozny points out, when employers don’t see the benefits a product like TrueConnect may offer for their employees, they also miss out on more immediately observable benefits to their businesses.
“At larger employers, 401(k) loans can require a tremendous amount of work to administer,” he said. “In some offices, we hear that there are employees whose only job responsibility is managing a 401(k) loan program.”
TrueConnect’s model often requires employers to adapt firm-by-firm. For example, some employers may see high turnover among new employees, but have good retention rates once their workers have been on board for a few months. In these cases, employers might need to increase the employment history required for taking out a loan.
If employers offer TrueConnect, they must also consider how they advertise the benefits, advised Thell. Managers at LSS were excited to roll out the program, but they quickly learned that they needed to be sensitive in how they let people know TrueConnect was available.
“We realized some employees thought they needed to meet with their manager to take out a loan,” said Thell. “We made sure to make it clear that they did this through an app, and that they wouldn’t need to talk about their personal financial details to use the benefit.”
Commonwealth’s work highlights the importance of messaging when employers offer up these benefits for their employees.
“Our research shows that low-wage employees appreciate the benefits their employers offer,” Gopnik said. “But it also highlights the importance of perceptions about a benefit. Employers should avoid stigmatizing it or being paternalistic. One way companies can do that is by making sure that a benefit is advertised as something for everyone, from janitors all the way up to CEOs.”
Scaling up to a better solution
Another TrueConnect adoption story from the Twin Cities shows how employees themselves have taken the initiative to gain access to the program. When Service Employees International Union Local 26 in the Twin Cities area was entering negotiations for its latest contract with a group of employers, the union’s leadership recognized TrueConnect as a potential tool for supporting its workers.
“We started talking to our members about the program before we even began negotiations,” said Greg Nammacher, Local 26’s secretary-treasurer. Those 8,000 members work as janitors, security officers, and airport staff. Many of them are immigrants and people of color.
The union saw the high cost payday loans had for their members and viewed TrueConnect as a way to help them save money when they face an unexpected crisis.
“Every month, we have members coming to our union hall asking for donations to help them cover car accidents, plumbing problems, and, most commonly, the funerals of loved ones,” said Nammacher.
—Greg Nammacher, Service Employees International Union Local 26
As of the end of April, about 700 employees of three different employers at the Minneapolis-St. Paul International Airport became the first members of the union to have access to TrueConnect, and Nammacher hopes to work with other employers to roll out TrueConnect soon. Nabozny sees the deal as one of the exciting examples of how TrueConnect can become accessible to more and more households that might otherwise have to resort to expensive credit options in a time of need. However, one hurdle is that the pace of adoption needs to quicken.
“The biggest frustration we have with the program so far is that employers are slow to take it up,” Nammacher noted.
Fortunately, Sunrise and Employee Loan Solutions are working to change that. In addition to finding unexpected partners like Local 26, the two have been working with joint purchasing programs and payroll processors to add TrueConnect as an optional service on larger platforms.
“Since we don’t really require offices to collect any new information, the TrueConnect burden on HR departments is already pretty low,” said Nabozny. “But if we make the product available through larger platforms that people are already using, it becomes as simple as flipping a switch.”
Such deals may also enable relatively small businesses to access TrueConnect. The model currently works with employers of 300 people or more, but incorporating it into HR information-management systems that firms of all sizes use would enable the program to scale up. And scale is the primary barrier to offering even smaller loans or lower interest rates.
No matter how widely the TrueConnect program is adopted in the future or how many loans it ultimately makes, it will never be a financial panacea. No single product or service is likely to demolish the barriers faced by low- and moderate-income families who find themselves struggling to make ends meet after a tough month. But by making small-dollar loans available easily, quickly, and affordably, TrueConnect offers a glimpse of a better solution than what is often currently available.
1 The APR, or annual percentage rate, is the rate per year that a financial entity either charges a customer for borrowing money or pays a customer for investing money. APRs on loans include the stated, or nominal, interest rate plus any other fees or costs involved.
2 Community development financial institutions (CDFIs) are specialized entities that provide financial products and services, such as small business loans and technical assistance, in markets not fully served by traditional financial institutions. For more information, visit our CDFI Resources web page.
3 Report on the Economic Well-Being of U.S. Households in 2016, Board of Governors of the Federal Reserve System, May 2017.
4 Paychecks, Paydays, and the Online Platform Economy: Big Data on Income Volatility, JPMorgan Chase Institute, February 2016.
5 Anthony Hannagan and Jonathan Murdoch, “Income Gains and Month-to-Month Income Volatility: Household evidence from the US Financial Diaries,” U.S. Financial Diaries working paper, March 16, 2015.
7 Timothy (Jun) Lu, Olivia S. Mitchell, Stephen P. Utkus, and Jean A. Young, “Borrowing from the Future: 401(k) Plan Loans and Loan Defaults,” National Bureau of Economic Research Working Paper 21102, April 2015.
10 According to a multi-year, two-million loan sample from the CFPB, as reported in Supplemental findings on payday, payday installment, and vehicle title loans, and deposit advance products, CFPB, June 2016.
11 According to a national survey conducted by Pew Research for its March 2015 report, Auto Title Loans: Market practices and borrowers’ experiences, and the CFPB’s previously cited Supplemental findings on payday, payday installment, and vehicle title loans, and deposit advance products.
12 See endnote 7.
13 See endnote 9.
14 See the Pew Research report cited in endnote 11.
15 In their paper “The Availability and Utilization of 401(k) Loans” (National Bureau of Economic Research Working Paper 17118, June 2011), authors John Beshears, James J. Choi, David Laibson, and Brigitte C. Madrian draw on the Survey of Consumer Finances, which they cite as the “only source of information on the reasons why individuals borrow from their savings plan”; that data lists the reason for 48 percent of loans as “other.”
17 See endnote 9.
18 See endnote 7.
19 Commonwealth’s recent work and research on increasing financial security for low-income workers is described in its report Financial Security in the Workplace: Making It Work for Financially Vulnerable Workers. Gopnik presented at Building Employee Financial Capability, an event presented by the Federal Reserve Bank of Minneapolis, Prepare + Prosper, the Greater Twin Cities United Way, and the Minnesota Chamber of Commerce in October 2017. A video of that presentation is available here.