Replace Overdraft Fees with No-Fee Early Access to Wages

Adam Rust

Small-Dollar Credit and Overdraft Charges are not the solution for short-term financial shortfalls. The better plan is to give workers access to their accrued wages earlier. There are two ways to do this - through an early pay service or through the simple two days early with direct deposit offering.

Too many Americans live paycheck-to-paycheck. Steep increases in the cost of labor, largely driven by the soaring cost of health care, mean that wages have stagnated even though worker productivity continues to increase.

It is becoming much harder for consumers to bear fluctuations in their expenses. Should we find the solution in a better small-dollar credit product?

At the bottom of this post, we'll provide links to two accounts that will let people acess their pay up to two days early without any fees or interest.

We know that we need an answer to this problem:

• Sixty-one percent of Americans have less than $1,000 in savings.  

Forty-six percent of Americans could not cover a $400 emergency expense without selling an asset like the car or their home.  

• Most small-dollar credit is costly. Interest rates on payday loans vary from state-to-state, ranging from 100 percent to 700 percent.

Paying workers once every two weeks, twice a month, or even once a month makes it that much harder for them to manage their money. We must admit that liquidity is part of the problem. More facts:

• Most low-wealth Americans work. Accrued wages constitute the largest asset for tens of millions of American workers.

• Unbanked Americans cannot use direct deposit to receive wages.

The goal should not be for a household to reduce its cost of credit from 400 percent to 36 percent. Why should we apply a different standard to those with less wealth? No one would say that the next step forward for upper-income households should be to reduce the interest rates on their credit cards. No, the right fix would be to eliminate credit card debt. So, let’s not be paternalistic. Let’s set the same goal – financial health - for everyone.

NOTE: Want to learn more about overdraft fees? Go to our research portal to find blog posts, research papers, legislative activity, and updates on fees.

I was hoping you could take a moment to construct a pathway in your mind because that will help to convey my idea here. If we start with the shortage as the starting point, consider how overdraft and small-dollar credit are both separate paths to be taken. Let’s narrow the overdraft path to only cases that involve payroll cards. Let’s narrow the small-dollar credit path to solutions that include an employer-based credit solution.

A gatekeeper is posted at the divergence. The gatekeeper is your employer. The gatekeeper can play a role in solving the worker’s problem. He or she might offer some small-dollar credit as a benefit.

The gatekeeper could block the employee’s entrance to either path. In most instances, when a worker faces a short-term liquidity crisis, he or she is left to his or her own devices. He might opt to utilize the kind of high-cost unsecured credit that is available in the marketplace. At best, that could be a consumer installment loan. Interest rates vary dramatically from state to state but are rarely less than 80 percent. In many instances, borrowers buy add-on products that reduce the lender’s risk. At worst, a worker could seek a high-cost payday loan, were protections are few, and interest rates can be as high as 700 percent.

Taking the other path, where the employer chooses a payroll card program with an overdraft feature, is also sub-optimal. Overdraft fees put much stress on a low-wealth workers balance sheet. At best, using a payroll card with an overdraft is a short-term fix. It answers the short-term needs of low-wealth workers at the expense of their future sustainability.

The NetSpend Skylight ONE Card, offered by several banks in conjunction with NetSpend’s platform, has had an overdraft option on its payroll card for years. Is that the right fix? In my opinion, the answer is no: payroll cards and overdraft do not mix.

Overdraft with any bank account creates problems. It is a temporary form of high-cost credit. In its recent study of overdraft programs, the CFPB reported that the average cost of a payment that triggered an overdraft was $24, but the average overdraft fee was $34.

That’s very expensive. How do we move people to a safer financial position? How do we go from vulnerable to healthy? The solution is not better access to lower-cost small-dollar credit. In my opinion, access to small-dollar loans is only a way to treat the symptom. It helps to ameliorate a crisis. If along the way, a person needs a tool to smooth the ups and downs between inflows and outflows, then small-dollar credit might be the support that keeps them on the path to health. But giving people access to the money they have already earned is far better.

More of our gatekeepers/employers should offer a short-term payroll advance solution as an employee benefit.

Early pay products allow a business to advance a portion of the funds that an employee has already earned. For example, if the employee is due to receive pay in four days and has already worked six days, then the employer could make some arrangement to give the worker access to several days of earnings.

The market has begun to develop these solutions. Large employers appear to see the benefit they can provide to workers.  

• Uber is partnering with Green Dot to offer Instant Pay to its drivers.

• Through a contract with Even, Wal-Mart can give employees early access to accrued wages. Within seven months of rolling out the service, 200,000 workers had utilized the service at least once.

  • Some businesses will appreciate Rain's scalable early payment program. Unlike Instant Pay, Rain can work with almost any sized company. Rain charges $2.99 for each early withdrawal via regular ACH and $3.99 for an immediate payout. Business owners can set limits on the frequency of use. The fee can be paid by either the employer or the employee.

Of note, both examples involve employers with millions of workers. That is not an accident. Deploying such a program requires much work on the part of payment processors, the technical providers of the early pay service, and the payroll departments of employers. Small firms may not provide the revenues to justify the work.  

Employers need to intervene. With so many workers living without any financial cushion, opportunities for scalable enterprises exist. Traditional fallbacks might work for the short-term, but they impose significant costs. We need to move past payroll cards with overdraft or short-term high-cost credit. The untapped opportunity exists with the employer.

Living from paycheck-to-paycheck is hard, but if workers could access their pay early, fewer would have to resort to high-cost short-term credit.

However, a meaningful change means more. A significant change occurs when households are not waiting for the next payday to catch up on bills. A low-wealth family leaps forward financially when it attains enough in savings to cover an emergency expense.

Overdraft is not the answer. I'm not too fond of it for checking accounts, and I'm not too fond of it for payroll cards. I think we are fortunate to witness the development of overdraft-free checkless checking accounts. Accounts like Varo, Axos Akimbo, and others create a “safe-rails” solution that can help people find their footing.

NOTE: I've also written about early direct deposit of pay.

Some banks will credit an account with an impending direct deposit as soon as the worker's bank receives a message from the payroll provider that a direct deposit is due to arrive. If the payroll message is sent on Wednesday for a Friday direct deposit, an early pay by direct deposit service will credit the worker's account with the full payment on Wednesday.

Two Bank Accounts that give account holders access to their pay up to two days early
Picture of card
Picture of card
Clock ticking on early pay without overdraft fees

How Banks Design Accounts to Make You Overdraft More

I understand that some people way see overdraft as a form of credit. I have heard that from many bankers. I heard it when bankers wanted to defend the use of “high-to-low” check sequencing.

To paraphrase from many conversations with bankers on the topic: “Customers want us to pay their big bills first.”

True, some customers may have had that perspective. However, customers come in all shapes and sizes, and it’s a certainty that many didn’t feel that way. High-to-low has the impact of creating more overdrafts. Some banks still use it, but luckily the number has declined. Perhaps that is due to regulatory pressure – I doubt they walked away from revenue voluntarily.

I can even understand those would say that messaging at the point-of-transaction would suffice. I have to agree with them. If a person was about to withdraw more than he or she had in available funds at an ATM, then would it be better if the ATM responded with:

• The amount of your available funds balance (balance – scheduled payments)

• The amount of the overdraft fee

• The amount of overage.

With that, a customer would know that going ahead with the withdrawal would trigger a $34 fee. They would be making an intentional choice. The banks defend the use of overdraft as a logical choice by an informed consumer. Well, we should develop mechanisms to support those perspectives.

Did you ever notice how the banks like to have it both ways when it comes to overdraft? They want to defend overdraft as a beneficial tool for getting over a rough spot.

Here’s what TCF Financial, a Minnesota bank with offices in about 20 states, said about the value of overdraft:

“We believe our customers who have elected to participate in our overdraft program view it as a valuable service they otherwise would not have had access to, which allows them to pay for life's necessities such as gasoline, groceries, or medicine.”  

The CFPB filed a lawsuit against TCF, citing the fact the bank managed to convince 66 percent of its customers to opt-in for an overdraft – a rate that outpaced the norm in the industry threefold.

TCH has become a legend in the overdraft policy world. TCF is the bank whose leadership pays for its saliboats with a salary derived from overdraft fees.

A few years ago, the Washington Post reported that TCF’s CEO had christened his boat the “Overdraft.”

Overdraft made a lot of money for his bank. TCF collects about $180 million per year in overdraft fees. Earlier this year, TCF agreed to pay a penalty of $30 million to the CFPB to settle the suit.

If overdraft deserves to be considered as a form of credit, then banks should be comfortable with a regulatory approach that views overdraft services as such. That would mean putting it under the scope of the Truth-in-Lending Act. Alas, they don’t see it that way.

Of course, TILA coverage would still have to fit the product. TILA gives borrowers certain privileges that would not square with the nature of overdraft, beginning with the right of rescission that allows borrowers to back out of loan within three days of its origination. It would, however, set up the grounds for better disclosures. I would like to see a regime where, in the case of a payment type that allows for real-time good funds verification, that the consumer is told the amount of the shortage and the amount of the fee. At that point, using overdraft becomes an intentional decision rather than a mysterious accident.

Paying overdraft fees, in much the same way as paying interest on a small-dollar loan, solves an immediate problem. Unfortunately, it soon adds additional expenses to already-constrained budgets.

Here’s the thing – employers should be a part of the solution. Some employers are offering early pay features.

Lately, financial institutions have begun to partner with employers to create services that advance paychecks to workers early. I like this idea when it is done properly. That means:

• Clear disclosures: make it clear to people that they are electing to receive pay now at the expense of the size of the future paycheck.

• Provide the service at low or no cost to the worker. If not, then we’ve only created a new way to favor the current moment over the future moment. If there does need to be a fee, then employers should bear the cost. While that view might appear to be unrealistic, doing so reduces regulatory paperwork that would otherwise be required as a condition of reducing wages.

• There should be some cap on the number of times it can be used.  

The key problem is that it requires much integration to create a payroll advance products. The bank has to know how much the employee has already accrued in wages. The employer needs to have a record of which employees have received an advance and for how much.

Some banks are following suit. WiseWage offers the Varo Money bank account. With Varo Money, consumers can use direct deposit to receive their pay up to two days early.

VISA just announced a new partnership with PayActiv that may help to bring early pay to scale. No employer should balk at offering PayActiv. It is entirely free for employers and it works with businesses of any size. It will not impact their cash flows, either, as PayActiv fronts the cash to the workers.

Workers should take their own initiative to get an account that offers early distribution of pay via direct deposit. In other words, if they think there is a possibility that they will run out of money before the end of their pay period on a recurring basis, then the worker should get a Varo Money Bank Account.

By the way, Varo Money just introduced a no-fee overdraft service. Varo will let account holders who meet certain criteria (direct deposit, minimum # of debit card purchases) spend up to $50 beyond their balance. Any request for payment of a greater amount will still be denied. All debts must be repaid before Varo will authorize new debits.

Early pay through accrued wages is the killer app that reduces the use of overdraft and also the demand for payday loans.

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Adam Rust has worked to defend consumers against harmful financial practices since 2005. He has written extensively about overdraft fees, payday lending, credit insurance, student loans, prepaid debit cards, high-cost installment loans, and subprime mortgage lending. The New York Times interviewed him when it reported on the CFPB's rulemaking on prepaid debit cards; subsequently, his research paper framed the debate on consumer protections.

He serves on the Board of the US Faster Payments Council. He is Director of Research at Reinvestment Partners in Durham, North Carolina. He is the author of BankTalk. He is the author of "This is My Home: Challenges and Opportunities of Manufactured Housing" and has testified to Congress on how to redress some of the problems with manufactured housing. See more on his LinkedIn profile.