Alternative banking services such as payday loans, check-cashing services and prepaid debit cards have long been associated with the poor and underbanked.
Yet a recent study finds a new group of enthusiastic users: millennials (the 18-to-34 crowd, also known as Generation Y) who are making as much as $75,000 a year.
These services may provide a quick, convenient, easy-to-understand way to make ends meet for a generation hit hard by the recession and swimming in student loans. But consumer advocates and financial planners warn that alternative financial products often come with exorbitant fees and are poorly regulated — and that consumers using these services should look for more cost-effective solutions.
Similar use regardless of income
Think Finance, a financial services company that develops alternative financial products, surveyed 640 millennials who make up to $75,000 annually and who had used an alternative banking product in the past year.
It found that underbanked millennials with mid to high levels of income are using alternative financial services at rates similar to their lower-income counterparts.
For example, the percentage of millennials who had used prepaid debit cards in the past year was the same (51 percent), whether they made $50,000 to $75,000 or made less than $25,000.
Some of the alternative products were used even more heavily by higher-income millennials than lower-income ones. The survey found that:
- Emergency cash products (payday loans, cash advances and other emergency cash products) were used more often by those making $50,000 to $74,999 (22 percent) than those who earn less than $25,000 (15 percent).
- 58 percent of respondents making $50,000 to $74,999 reported using overdraft protection compared with 31 percent making less than $25,000.
The study also found millennials were generally happy with the way these products worked: A significant majority (83 percent) who use emergency cash products had a positive or neutral experience.
“Millennials represent the Internet generation,” says Think Finance’s CEO Ken Rees. “They demand speed and convenience. Some alternative financial services providers may offer that more than banks in certain cases, such as emergency cash access.”
Consumer advocates say alternative financial services are costly and can trap users in a cycle of debt. Moreover, because emergency lenders and prepaid debit card issuers don’t report to the credit bureaus, their services won’t help users build healthy credit histories.
Concerns about hidden fees and widely varying terms have led the Consumer Financial Protection Bureau to start developing the first-ever federal protections for prepaid cards. Currently, prepaid cards don’t have the same protections as debit cards linked to a checking account.
The Center for Responsible Lending (CRL), meanwhile, warns against payday loans. According to CRL, the typical payday loan borrower can expect to be indebted for half the year, buried under annual interest rates of more than 400 percent.
Financial planner Casey Weade, vice president of Howard Bailey Financial in Ft. Wayne, Ind. (and a millennial as well) agrees with these negative reviews.
“It’s a lot like a crutch, like giving an addict a cigarette,” he says. “If these products didn’t exist, it would force hard lessons to be learned. It would force us to budget.”
Weade says he sees it all the time: His peers graduate from college, start out making $50,000 to $60,000 and start buying things without first paying off their loans.
“Just because you make more than the average American doesn’t mean you can afford to live better than that group, especially if you have a large amount of debt,” he says.
This generation is facing student loan debt like never before. In 2011, the national student debt load hit more than $1 trillion, surpassing even credit card debt.
That debt load has to be addressed before millennials can start buying the cars, TVs and electronic gadgets they want and feel they deserve, Weade says. Also, because alternative products don’t help build credit, millennials are missing out on building up an important part of their financial lives, Weade says.
Weade suggests starting with a credit card limit of as low as $500 and paying it off each month to build a positive credit history. Secured cards, which are backed by a deposit, are also a good place to start, he says. For those who just want to stay away from traditional banks, credit unions may offer the customer service and transparent fees millennials seek.
Eyes wide open?
Preston Swincher, a consultant with The Center for Generational Kinetics in Austin, Texas (and a millennial), says Gen Y consumers do understand the choices. He says it’s not lack of financial literacy that’s driving these decisions, but an unflinching demand for convenience and transparency.
“You have to remember, we are so well connected to information,” Swincher says. “If I want to pay a price for something, I’m going to know what the alternative prices are. …We’re the most informed generation to ever have to make these decisions.”
Millennials are often willing to pay more for products they see as easier and more trustworthy, Swincher says. They are tired of being zapped by unexpected overdraft fees or reordered checks — the practice of banks cashing the biggest checks first instead of in the order they’re posted, which can start a ripple effect of overdraft fees.
“A lot of these things labeled as alternative services, we don’t view as alternative services,” Swincher says. “For us it’s just another service that makes a lot of sense, like prepaid debit cards. For us it’s like a slightly more complicated gift certificate.”
While Gen Y consumers value immediacy and trustworthiness, banks, Swincher says, can feel overwhelming and not user-friendly. Banking alternatives are winning over millennials because customers can walk in, immediately get results and walk out again.
Winning back the millennials
Alternative financial services, Swincher says, “are starting to do a great job of marketing and being transparent about what you’re getting into.”
That leaves more traditional financial institutions looking for ways to regain access to the millennial market. Credit card issuers may be in an especially tight spot since the Credit CARD Act of 2009 stopped the practice of marketing cards on campus. It also prevents anyone younger than 21 from getting a credit card unless a parent co-signs or the person has sufficient income to qualify.
American Express, for instance, which typically targets a higher age and income demographic, is targeting young consumers with its new prepaid card aimed specifically at college students, which is available at college bookstores.
Financial services that win millennials’ business will likely have to develop products that satisfy their demands for convenience and transparency without attaching costs consumer advocates say are predatory.
“It is important for Gen Y to research what’s available to them in terms of financial services and make an educated decision,” says Think Finance’s Rees. “And it’s equally important for those of us in the industry to constantly strive to develop more innovative solutions.”