Start Saving to Stop Spending Money on Alternative Financial Services (AFS) - Part 2

By Megan Brewster, Coordinator to the Associate Director, and Meredith Covington, Project Director, Center for Social Development, Washington University in St. Louis.

In yesterday’s post, we examined data that show most low- to moderate-income (LMI) households who use alternative financial services are significantly worse off financially than counterparts who do not use such services. Alternative financial services include check cashing, payday loans, etc.

So what do these statistics actually mean for the household budgets of American families?

About $1,100 in fees and interest annually: That’s the average amount paid each year by unbanked LMI American households for alternative financial services. Roughly 5% of a LMI household’s annual income is spent cashing checks, managing payday loan obligations, and accessing other financial offerings from providers who are not federally insured. In purchasing power, that sum amounts to eight weeks’ worth of groceries for a family of four or rent for almost a month and a half. It’s not a small chunk of cash.

While even providers of alternative financial services themselves note their services are not a smart long-term financial solution, far too many families find themselves turning to these services again and again.

What can be done instead?

Saving – specifically, saving a tax refund—is one strategy that can help. Savings enable people to prepare financially for inevitable financial shocks like job loss and car problems and avoid turning to alternative financial services. Additionally, unlike alternative financial services providers, savings accounts with insured institutions are backed by the U.S. government, offering protection for hard-earned cash. Additionally, a savings account is also a gateway to other beneficial financial services, such as check cashing without fees.

Tax time is a golden moment for saving, as the tax refund may be the largest lump sum most LMI households receive all year. The survey data indicate that the average federal refund received by LMI users of alternative financial services was over $2,500 in 2013. Additionally, the data show that having more in savings is associated with less use of alternative financial services.

As the evidence suggests, use of alternative financial services is linked with poorer financial outcomes--but saving can limit the need for such services. Below we suggest individual strategies for prioritizing saving—one dollar at a time.