No Slack: The Financial Lives of Low-Income Americans

Managing Money

22 This chapter presents an overview of the empirical evidence documenting the financial services behavior and attitudes of low- and moderate-income (LMI) households. The Detroit Area Household Financial Services (DAHFS) survey uses a random, stratified sample to explore the full range of financial services used by LMI households, together with systematic measures of household preference parameters, demographic characteristics, and households’ balance sheets.1 Results from the study suggest that the structure of formal and informal financial services makes it more difficult for low- and moderate-income households to manage their money. Given the lack of financial slack these households have, managing their finances is a key task. Yet the financial services system, rather than facilitating this endeavor, often makes it harder. Within the severe income constraints they face, LMI households seek to use both formal and informal mechanisms available to them to manage their financial lives. Like their higher-income counterparts, LMI households regularly conduct financial transactions: they convert income to a fungible medium, make payments, save, borrow, seek insurance, and engage in financial and economic decisionmaking. Yet the formal and informal financial services systems are not designed to serve them well. Often, the financial services available to these households are too high cost, or high risk, or confusing to them and make it more difficult to build a measure of financial stability. Managing Money michael s. barr 2 1. I was the principal investigator for the DAHFS study. managing money 23 The line between the formal and informal financial services systems used by LMI households is not impermeable. Contrary to popular belief, being unbanked is not necessarily a fixed state. Approximately 70 percent of the unbanked previously had a bank account, and more than 10 percent of banked households were recently unbanked. While the unbanked are much more likely than banked households to turn to alternative financial services (AFS) providers, such as check cashers, even banked individuals often use some such provider. In fact, one type of alternative credit provider, the payday lender, exclusively serves banked individuals. The financial services choices facing households are complicated; these choices not only involve trade-offs among functionality, convenience, and cost but also require cost comparisons across highly differentiated products in both the AFS and formal sectors. Alternative financial transactions are often described as convenient but high cost; at the same time, bank accounts are also perceived as high cost and not usually well structured to serve LMI households. For example, over half of banked LMI households reported paying minimum balance, overdraft, or insufficient funds fees in the previous year. The financial services mismatch— between the needs of LMI households and the products and services offered to them—forces these households to choose among the high-fee, ill-structured products offered by both banking and AFS institutions. These constrained choices reduce take-home pay and make it harder to save and more expensive to borrow. The Financial Services Marketplace for Low- and Moderate-Income Households Although the overwhelming majority of low- and moderate-income households have and use bank accounts, both these households and their unbanked counterparts often face high costs for using basic financial services, significant barriers to saving, and more expensive forms of credit (Barr 2004; Barr and Blank 2009). High-cost and inadequate financial services reduce take-home pay and increase the costs of administration and compliance for essential governmental programs, including Social Security, the earned-income tax credit, and income transfer and welfare-to-work programs administered by states. In addition, high-cost and inadequate financial services diminish the opportunities for LMI households to readily save. Saving is critical for LMI households, in part because they are vulnerable to income shocks, medical emergencies, and other expenses such as car repairs that can upset their fragile financial stability. Moreover, the lack of a bank account and savings increases the cost of credit for these households, reduces their opportunities for stable home ownership through sound credit choices, and diminishes their ability to save or borrow to invest in their own human capital and that of their children. 24 michael s. barr According to national figures, about 25 percent of low-income American households (defined as the bottom 20 percent, who earn under $20,600 a year) are “unbanked,” that is, they have neither a checking nor a savings account (Bucks and others 2009). Even among moderate-income households (those earning up to $30,000 a year), 13 percent...