California may point the way forward on payroll advances
It’s easy to criticize the payday lending industry for its high fees and repetitive loan rollovers.
But it’s much harder to come up with an alternative for people who need cash immediately yet have poor or nonexistent credit histories.
California, however, is the state closest to finalizing laws that define and regulate the earned wage-advance product, which allows employees to get an advance on some of their paycheck before payday, also called wages-on-demand.
The fee for getting an earned wage advance is usually small, making this product an extremely attractive alternative to payday loans. While some federal agencies and state lawmakers are reviewing this product, California is making headway on regulations to clarify the product, even though it does not fit neatly into existing lending laws; and poses real threats to the employees who use it.
The bill recently had its third reading, making it eligible for a final vote soon. Thus, California is poised to pass the first law in the nation that will clarify the legal status of earned wage advances and set some basic consumer protection standards.
Because California is leading the way for the rest of the country, lawmakers have to get this one right. It settles a thorny legal question for companies providing the product: is an earned wage-advance a loan?
The proposed legislation would explicitly clarify that this new product is not considered a credit, since it’s earned wages. Therefore, it is not governed by California’s lending laws. That is a win for the industry, which has been plagued by uncertainty.
There are also wins for consumer advocates, too. The bill makes the advances nonrecourse. Meaning, if an employee gets an advance but their paycheck later does not cover it, the company that gave the advance can’t come after the employee in court or through debt collectors.
In addition, the bill places a cap on fees for the product. This ensures that the legislation won’t just create a work around for predatory lenders who want to charge high prices but avoid lending laws.
Yet California could do more in protecting consumers to set an example for other states. Most important, lawmakers should include a restriction on abusive contract terms in earned wage-advance companies’ contracts.
Most of these companies have contracts that are actually worse for consumers than payday lenders. There are more mandatory arbitration clauses, waivers of the right to sue as a class and more rights for the companies to amend the contracts unilaterally, for example.
The California legislature cannot prohibit all of these clauses but it can prohibit some. And the current bill does little to prevent these types of abusive terms.
It is unlikely that people using earned wage advances will read or police the contract terms, so the legislature needs to step in to help.
In addition, California should require real-time disclosures to employees about the effects of getting a wage advance. People in America have been getting paid weekly or biweekly for a long time. And it is not clear how well employees will adjust to having the chance to get the money they have earned almost instantly.
To safeguard against employees getting advances early in a pay period and spending the money that should be used for rent, lawmakers could require that earned wage-advance companies make disclosures about the consequences of obtaining an advance at the time the employee requests it.
Many of these companies have access to the employee’s bank records so the app could warn an employee seeking an advance to save sufficient funds for large upcoming expenses.
The solution to payday lending in California — and elsewhere — is providing a law that facilitates an alternative rather than shutting down a product.
Earned wage advances are a cheaper, better source of liquidity for lower-income employees.
Lawmakers can indirectly tackle payday lending by establishing certainty for the companies in the earned wage-advance market, and by offering protections for the employees who use it.
By ensuring the consumer protections are strong, California can set the stage for a wave of bills across the nation that encourage earned wage advances that challenge payday lending with a truly consumer-friendly alternative.