Famed rapper Nasir Jones (“Nas”) made a poor choice in backing a revolutionary new financial services product that provides “earned wage access” to employees.
A variety of earned wage access companies have popped up in recent years, but only one of them has a model that is worse than the payday loans it’s designed to replace.
Regrettably, Nas chose to support that one startup, called Earnin. Let’s not hold it against him, though, because his heart is definitely in the right place. He just didn’t do enough research.
Earned wage access lets employees spend the wages they have earned in a given pay period before payday arrives. Since most employees are stuck in the two-week pay cycle, they are often in need of some of that money they have earned simply to make ends meet in the interim.
Imagine it being Thursday of the first week in your pay period, and you need $60 to buy some gasoline for your car, so you can continue to get to work.
Up until about 20 years ago, you would probably write a check that you knew would bounce. You’d fill up your tank, and at the end of the month, you’d owe $30 in overdraft fees, plus $25 in merchant fees.
That’s a very expensive loan.
To alleviate this problem, payday lenders appeared on the scene.
With a payday loan, borrowers could get a loan that could be repaid with the money from their next paycheck. The short-term loan was fast, convenient, easy, and didn’t require a credit check. The fact that it was unsecured and short-term in nature meant it was also relatively expensive.
Payday lenders generally charged $15 per $100 borrowed.
Regrettably, some unscrupulous lenders took advantage of consumers. Many would get caught in a “cycle of debt” because these lenders would encourage them to repeatedly roll-over the principal, and collect the fee every two weeks.
Earned wage access is known as the “payday loan killer” because of its radical structure.
A third-party, such as Earnin, floats the employee whatever money they need, usually with a cap of 50% of net wages earned up to that moment. That money is directed to the employee via debit card or bank account.
That third party then recovers the amount it floated to the employee directly from the employee’s payroll account on payday. The provider also collects a small fee in exchange for the service.
Every company in this space has a different fee structure, but generally, those fees run between $5 and $7 per pay period.
That is substantially cheaper than a payday loan.
Except for Earnin.
Earnin decided on a fee structure that was poorly conceived and has already gotten the company in hot water with the regulators of 11 states.
Earnin called its fee a “tip,” rather than a fee.
This tip is optional and could be for any amount that the employee chose. Were it as simple as that, the company would probably not be in the kind of trouble it’s facing, and Nasir Jones wouldn’t be losing sleep.
The company ran into trouble by suggesting that an employee tip $9 for every $100 advanced. On an absolute basis, that’s not as expensive as a payday loan. It’s 40% cheaper.
But there is a critical difference between the payday loan and this earned wage access service.
A payday loan is an unsecured loan, meaning the lender has no recourse to collect its money back from the borrower, outside of hounding them or sending their account to a debt collector. That’s why the fee had to be so high. Too many defaults would swamp the fees that got collected on good loans, and the lender could literally go out of business.
But that’s not the case with earned wage access, because Earnin and other providers have direct access to the employee payroll accounts. Repayment is effectively guaranteed.
Because this functions as a secured loan (although there is some dispute as to whether or not it is actually a loan), charging 9% was a poor choice. The suggested price didn’t need to be that high, even though the tip is merely “suggested.”
That’s because most people, thankful to obtain their own cash at a point when it is desperately needed, are likely to pay that suggested amount. There are reports that some people were paying as much as $14 per $100 borrowed.
There is an argument to be made that this is the free market, and consumers are free to choose to tip the company whatever they choose. That’s absolutely true.
Yet there was one other wrinkle to Earnin’s fee structure.
The smaller the tip, the less money an employee would be able to have access to.
That encouraged employees to tip more in order to have access to higher advances.
Again, one could rightly make the same argument regarding the free market and consumers’ freedom to choose.
Except the free market doesn’t consider the “O” word: optics.
Bad optics significantly increase the chances of regulatory crackdown. The optics on Earnin’s fee structure are terrible. All that regulators and activists will see is “$9 per $100 advanced.”
Even worse, they’ll see “$14 per $100 advanced” and scream “payday loan!”
Trust me, after years of handling public relations for the payday loan industry, I can say that a company doesn’t want to be in the position of having to defend payday lending. There are plenty of reasoned, logical, free-market arguments to be made in defense of payday loans, backed by hard data.
It doesn’t matter. When it comes to optics and politics, it’s a losing battle.
Whoever was advising Nas failed to talk to the right people (wink-wink) before suggesting he back this particular application.
Regulators are now looking at Earnin because there is a legitimate case to be made that the product is nothing more than a disguised loan.
There are plenty of arguments on the other side, and that includes the company insisting this is a “non-recourse transaction.”
The legal argument is very nuanced and lengthy, but in this particular case, all that matters is the company is now caught in the web of regulatory intrigue. And so is Nas.
Nevertheless, earned wage access is a fantastic concept and product. A number of companies are providing services that will revolutionize how employees get paid.
Earned wage access is a lifesaver, and Nas is right that it could eventually destroy the payday loan industry once it scales.
It just needs to make sure that it proceeds with caution through a very active regulatory and public relations minefield.
Disclaimer: The views expressed in the article are solely those of the author and do not represent those of, nor should they be attributed to, CCN.com.