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Chapter 3 Financial Services, Saving, and Borrowing Among Low- and Moderate-Income Households: Evidence from the Detroit Area Household Financial Services Survey Michael S. Barr T his chapter presents new 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. Results from over one thousand interviews in the DAHFS study suggest that the structure of the financial services, credit, and payments systems in the formal and informal sectors imposes significant costs on LMI households. 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 necessary financial and economic decisionmaking . Yet the formal financial services system is not designed to serve them well. 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 to turn to alternative financial services (AFS) providers, such as check-cashers, than banked households, even banked individuals often use some AFS providers that operate outside the formal banking system. 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 66 / require cost comparisons across highly differentiated products in both the AFS and formal sectors. AFS transactions are often described as convenient but highcost ; 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 largely 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, making it harder to save and more expensive to borrow. This chapter begins by briefly describing the financial services marketplace for low- and moderate-income households based on prior research. The following section describes the source of the new data for the chapter regarding the financial services behaviors and attitudes of LMI households. Next is an analysis of the mix of banking and alternative financial services used by banked and unbanked households, the reasons why LMI households use these services, and the tradeoffs involved in their usage decisions. The chapter then turns to the savings patterns , attitudes, and decisionmaking of LMI households. The chapter concludes by suggesting directions for financial services and savings policy. THE FINANCIAL SERVICES MARKETPLACE FOR LMI HOUSEHOLDS The formal financial services system does not serve LMI households well. 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 transacting basic financial services, significant barriers to saving , and more expensive forms of credit (Barr 2004; Barr and Blank, this volume). 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 (EITC), 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 save readily. Saving is critical for LMI households, in part because LMI households are vulnerable to income shocks, medical emergencies, and even car repairs that can upset their fragile financial stability. Moreover, the lack of bank account ownership and savings increases the cost of credit for these households, reduces their opportunities for stable homeownership through sound credit choices, and diminishes their ability to save or borrow to invest in their own human capital and that of their children. Nationally, nearly 25 percent of low-income American families—those...


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