When Connor Smith saw an Instagram ad for mobile app EarnIn in early 2021 that said he could access up to $100 from his paycheck before payday, he thought it was a convenient way to pay for a night out. I thought so.
About a year and a half later, the Georgia resident says he was stuck in a “vicious cycle” of borrowing money from several similar apps to cover bills and other regular expenses. Smith said the app used up a large portion of each paycheck in repayments before he even saw it.
Recent research by consumer groups and government agencies suggests that the debt cycle Smith fell into may be common among users of cash advance apps, also known as paycheck apps. Consumer advocates and financial experts warn against relying on services that promise quick cash advances and look for other ways to cover expenses as everyday costs like groceries remain high due to inflation. It is recommended that
How the salary advance app works
Payroll advance apps offer small advances of a few hundred dollars or less, with repayments directly from the user’s bank account on the next payday.
Instead of a credit check, the app typically looks at the borrower’s connected bank account to determine the advance limit and repayment date.
Andrew Kushner, senior policy adviser at the Center for Responsible Lending, said that although the apps screen users’ transactions, there appears to be no safeguards to prevent people from borrowing from more than one app at a time.
Apps often ask for tips and optional expedited fees, which can reduce funding times from several business days to a few hours or less. This makes a big difference for borrowers who are struggling with cash flow.
Are cash advance apps the same as payday loans?
Cash advance apps are similar to payday loans, but they are not exactly the same. Fees are often low, most are optional, and upfront amounts are usually smaller than with payday loans.
Regulators currently do not classify these apps as lenders. That means they don’t have to follow general lending laws, such as the Truth in Lending Act, which guarantees specific consumer protections.
But Kushner said the app functions as a small payday loan that borrowers can borrow more frequently.
From 2019 to 2021, users of cash advance apps borrowed money an average of 26 to 33 times a year, according to a March report from the U.S. Government Accountability Office. According to his 2012 study by the Pew Charitable Trusts, the average payday loan borrower takes out about eight loans a year.
“If you take out more loans, what you’ve actually done is split the payday lending cycle into much smaller, more frequent direct-to-consumer sales,” Kushner said.
How a one-time loan becomes a debt cycle
Smith had planned to download EarnIn and enjoy it for the night, but since he was working unpredictable hours at the time, he also received an advance payment to make up the difference in income.
Smith says that when he was most dependent on cash advance apps, most of his paychecks were gone from his bank account before he ever saw them. He then received advances from 7 or 8 apps and had to get his funds back. This cycle was repeated every pay period.
“It got completely out of control and I had to live off of apps,” he said.
In August 2023, the Center for Responsible Lending found that most users typically borrow from apps once or twice a week per month, and 24% of users regularly borrow from multiple apps. We have reported the results of a survey showing that.
“I think this shows that people are in a debt trap,” Kushner said. “They basically have to continue to borrow and pay these fees just to get back to where they were before.”
A small fee will be added
Not only did Smith receive a portion of his salary early, but he also lost money by paying upfront fees.
Most companies that offer cash advances refuse to compare them to traditional lenders, but to understand the cost of a cash advance, it helps to look at it through the lens of a loan.
Let’s say you borrow $200 today using a cash advance app. The app charges a $7 expedited fee to get your money in hours instead of 2-3 business days. The app also asks for a tip. Some payroll advance companies say that users’ tips average $1, so they add that to the total.
I paid $8 to borrow $200. If the salary arrives within his 7 days, the fee is equivalent to 208.6% per annum. This is much higher than the maximum annual interest rate of 36% recommended by consumer advocacy groups for small loans.
“The fees seem very low at the time, but they add up,” Smith says. “It quickly gets out of control. I think that’s what people don’t realize they’re using those apps for.”
Alternatives to cash app
Brandi Baxter, a Dallas-area certified financial counselor (AFC) who studies trends in financial services, says it’s possible to use cash advance apps without getting stuck in a debt cycle.
The key, she says, is to only borrow money if you know you can repay it. But for people living paycheck to paycheck, that’s easier said than done.
“For hourly employees, anything can happen between the date you receive the loan and the repayment date,” she says. “The mobile app will debit your account no matter what. They don’t care if you don’t work the hours you were supposed to work.”
Here are some borrowing alternatives recommended by Baxter.
Find other ways to make money. Look for other sources of income, such as selling second-hand clothes or doing additional work online. Finding time for a side job can be difficult, especially for working parents. So Baxter recommends thinking about what you’re already doing, like cooking or caring for your children, that you can charge money for.
Take advantage of payment plans. If you have an unexpected expense, ask about payment plans. Doctors, veterinarians, and auto repair shops may offer interest-free payment plans or work with “buy now, pay later” companies to split large expenses.
Talk to a financial counselor. Baxter said the Association for Financial Counseling & Planning Education has a network of counselors who can help you review your cash flow and create a plan to work toward your financial goals. Ask about costs up front: Some AFCs charge a fee for their services, but if you work for a nonprofit, you may not.
The article Paycheck Advance Apps Can Mean Just Fast Cash — or a ‘Vicious Cycle’ originally appeared on NerdWallet.
