Last week we laid out an ambitious vision: the country’s leading financial institutions marketing to the country’s poorest customers. While it may seem like a tough sell, the unbanked and underbanked market represents more than 28% of American families, who each year spend millions on sometimes predatory alternative services. In this series, we’re exploring this demographic and ways that companies like yours can reach them. This is the second part in our series, looking at what consumers do when they can’t access a bank. If you missed part one, you can read it here.
You’ve probably heard of the “food desert,” right?
This is the concept popularized in recent years to explain why some neighborhoods and towns have little to no access to fresh, healthy food. In many cases, it’s because residents have to travel long distances— one mile or further in a city, 10 miles or further in the country— to access a grocery store. With no healthy alternatives nearby, families often rely on cheaper processed food that’s high in fat.
The same idea can be applied to banks and access to financial services. A study from the University of Wisconsin found that more than 300 urban and 600 rural communities suffered from bank deserts, with minorities more likely to live in an area not serviced by a bank. Hispanic residents living in rural areas were the most likely communities to live without access a bank, according to the study.
In a bank desert, consumers must find often “unhealthy” alternatives that are conveniently located inside their communities. Many of these are the alternative services we talked about in part one of this series, which sometimes take advantage of low-income customers by levying high interest or steep payment terms on loans and other services.
So what are these so-called “alternative financial services,” and how do they work?
Payday loans
Payday loans are small loans, generally under $500, that are available to a wide array of customers who may be unable to get a loan elsewhere due to poor credit history. They have a very brief period in which to pay them off, making them difficult to pay off fully, especially for a person who needed the loan to cover expenses in the first place. If they aren’t paid off in time, they must be renewed.
They can be very damaging if they spin out of control— and for too many customers, that’s the reality.
A 2014 study from the Consumer Financial Protection Bureau found that consumers using payday loans were “caught in a revolving door of debt,” with four out of every five payday loan customers renewing or “rolling over” their loans— frequently as often as six times. The report even found that borrowers sometimes owed more in loan fees than their actual loan was worth.
Some states, like New York, have banned the payday loan because they say the loans “are designed to trap borrowers in debt.”
Check cashing services
What if a bank won’t cash your check because you don’t have an account, or because the check originated at another bank? Or, in the case of bank deserts, what if the nearest bank is miles away?
Neighborhoods throughout America feature unassuming storefront check cashing facilities, where unbanked or underbanked customers can pay a fee for their check to be converted to cash. In many outlets, customers can also pay bills and wire transfer money, too.
But not all check cashing providers are equal. As Dollars and Sense noted, in states where check cashing outlets are regulated, operators are often restricted on the amount they can charge to cash a check, as well as the types of other financial services they can provide. For customers at these outlets, check cashing facilities provide an easy and up-front way of managing their money, even if it involves losing a small portion to fees.
In those cases, cash checking outlets are often the most stable financial services available to the poor.
But unfortunately, that’s not the case everywhere. In other states with few or no regulations, cash checking businesses can be run with little oversight. That can mean fees that are virtually uncontrolled.
For customers in those states, a trip to a check cashing provider to cash a check could lead to heavy fees and further debt.
Auto title loans
According to a report from the Pew Charitable Trusts, roughly 1% of Americans rely on auto title loans annually, in which they turn over the title of their vehicle to the lender in exchange for an agreed-upon loan. Fail to repay the loan (and often an accompanying fee) within the allotted window and the lender can keep the car.
The report notes that the typical borrower ends up spending roughly $1200 in fees alone on an average $1000 loan. Up to 11% of borrowers lose their cars, the researchers found.
This is an often predatory system that can be extremely risky for borrowers. For many, their cars are their lifelines to employment and child care, and may, in some cases, be their most valuable asset.
So what can a mainstream financial business learn more from these examples?
It’s important to note that it’s not just “desert” conditions that lead customers to alternative services— inability to pay minimum account balances, a bad credit history or a distrust of big banks can all lead someone to turn to these alternatives.
What all three of these services count on is that unbanked and underbanked customers— whether they live in a “bank desert” or not— are not shopping for best price or most favorable loan terms. What the typical customer needs is a service that is understandable, quick and easy to access. As Pew puts it, “lenders tend to compete most on location, convenience, and customer service.”
According to research, the very banks who could compete with these services are often seen as intimidating, alienating and expensive by the very people who could use them the most.
Next week, we take a closer look at this demographic, why they make the choices they do and what it tell us about mainstream financial institutions.
