Unexpected expenses can leave you feeling stuck if you don’t have funds available to pay for them. Some companies offer payroll advance services to help employees bridge the financial gap between paychecks and avoid higher-cost options. But they’re not necessarily a good choice.
An employer-led payroll advance is when a company, either directly or through a third party, allows you to obtain part of your upcoming paycheck days or even a week or so ahead of time.
Traditionally, payroll advances have been rare requests by employees. But the digitization of the payroll process has made it easier for a company to make money available when employees need it.
Employees would most likely use this service if they had a bill they were scrambling to pay or last-minute expense, says Bill McCracken, president of Phoenix Synergistics, a marketing research company that serves the financial services industry.
“For an employer to make available part of a paycheck to pay that bill, I think that’s a positive,” McCracken says.
A common type of payroll advance not tied to your employer is a payday loan or cash advance, which is offered through a bank or credit union alternative, such as a check-cashing service. These types of short-term loans provide immediate cash, but can be very expensive for borrowers.
“The thing that really differentiates this product from a payday loan is the fact that it’s tied in with the employer,” says Glen Sarvady, managing principal of 154 Advisors and a payments expert working with credit unions, banks and financial technology companies.
With an employer-led payroll advance system, employers partner with a third party – often a fintech – to offer payroll advance as a benefit to employees, giving them a chance to borrow against the next paycheck.
In recent years, several businesses, including Walmart, signed partnerships with companies to provide payroll advance services to their workforce.
In the case of Walmart, employees who sign up for the program can get an estimate of hours worked and accrued earnings on a mobile app. Depending on the employer, employees could be charged a small, flat fee for each pay period in which they use the service and get the money sent to a bank account, a card or even to pay a bill directly.
Other services available through an employer-led payroll advance arrangement could include savings options, online bill paying and financial counseling. Often, there are limits on how much an employee can borrow, such as no more than 50% of an upcoming paycheck.
Payroll advance fees are usually lower than a payday loan because it’s a lower risk for the payroll advance partner company.
“They know the next paycheck is coming,” Sarvady says.
With many Americans living paycheck to paycheck – as much as 78% of U.S. workers, according to a 2017 CareerBuilder survey – a benefit like payroll advance could help cover emergency expenses. Also, according to the 2019 Charles Schwab Modern Wealth Survey , only 38% have built up an emergency fund .
The situation gets worse at lower income levels. It’s tougher for lower-wage workers to manage emergency expenses without taking out a payday loan or triggering an overdraft on a bank account .
An employer offering payroll advance can “address a little bit the cash flow crisis that is a very real part of the day-to-day lives” of low-income workers, McCracken says.
For someone who doesn’t have much money on hand, obtaining the money immediately is vital, because they might have bills that need to be paid by 5 p.m. that day, he adds.
A payroll advance system is also valuable for people with inconsistent pay and hours, such as restaurant workers or ride-share drivers.
“I think there’s a natural correlation with the gig economy,” Sarvady says.
Offering a service such as payroll advance also can help limit worker turnover and ease day-to-day financial-related stress for employees.
As with any service that allows you to borrow money, there are potential downsides, especially for employees who continually take paycheck advances.
“They can have a role in helping people with occasional expenses,” says Lauren Saunders, associate director of the National Consumer Law Center, which works on consumer-focused issues for low-income and other disadvantaged people. “My concern is that they can easily lead to chronic use that is similar to payday loans.”
For example, if someone continually gets payroll advances, it can be “kind of a sugar rush,” Sarvady says. “It’s only as good as people being fiscally disciplined.”
For employees, it’s important to make sure the payroll advance service is tied to your employer and its payroll system, McCracken says.
“The so-called early wage access apps that are offered directly to consumers are just a payday loan,” Saunders says. “They have no connection to actual wages.”
Before taking out a payroll advance, consider the long-term consequences. Ask yourself these questions to determine whether you can manage this fast money option.
Is there a limit on the amount of advances? “There should be a limit to the amount that you can advance because you don’t want a situation where you can advance 100% of your check” because you still have regular, ongoing bills to pay with each paycheck, McCracken says.
“If you couldn’t afford $300 out of this paycheck, why can you afford it out of the next paycheck?” Saunders says.
What are the fees? “The fees and interest rate should be reasonable for this type of product,” McCracken says. An employee can weigh those costs against payday loan rates – where the annual percentage rate can be as high as 400% – as well as the overdraft costs for banks, which average about $30.
Is there a limit on the number of times you can get an advance? If there are too many advances, it defeats the purpose and you’ll “get the employee into a cycle of borrowing where they have nothing in their paycheck,” McCracken says.
Some employers offer financial education through the third-party payroll advance company. But it’s better for employers to structure the product so it’s safe rather than offer a product that lets people get behind in a paycheck, Saunders says.
In the end, payroll advance is a loan, “but you’re borrowing from yourself,” McCracken says. “The company has a vested interest to make sure the employee doesn’t get in over his head.”
A employer-led payroll advance program is different from a payday loan primarily because it’s connected to the employee’s payroll, rather than being a transaction with a company that’s not connected to the employer.
There are also differences in the method of borrowing and cost.
With a typical payday loan, you set up a loan agreement with the lender for the amount of money you want to borrow; states often limit the amount to no more than $500. Once you get paid, the lender needs to be reimbursed the amount you borrowed, plus a fee. If you can’t pay the loan back in two or four weeks – the most typical loan periods – the fee continues every two- or four-week period until the loan is paid off.
Payday loan fees can be steep; if someone takes out a $100 loan with repayment in two weeks, a fee of $15 could equal an APR of about 400%. The maximum credit card APR , for example, is generally about 30%.
Also, since your employer is not involved in the transaction, it can’t limit how many times you borrow against your future earnings, as may be the case in an employer-led program.
It’s possible that, in the future, many companies will allow employees to get their pay more quickly on a regular basis, maybe even every day.
The traditional two paychecks per month model “has been in place for decades now” largely because of the administrative burden for companies to process, print and distribute paper checks, Sarvady says. As a result, people earn most of the paycheck before they receive it.
“The question comes up: ‘If I already earned the money, why do I have to wait for it?'” Sarvady says.
Some companies are already working with employers on business models that allow for daily access to earned wages at a cost per transaction for employees, or at a pace that’s driven by employees who choose one of a variety of time options at no cost to them.
A daily-pay scenario can “go through a normal payroll process,” says Caton Hanson, co-founder and chief legal officer of Nav, which helps business owners manage credit. “It’s not necessarily an advance. You earned these wages today. Here you go.”