Increasing numbers of cash strapped employees have turned to salary advance schemes during the coronavirus lockdown. But the Financial Conduct Authority (FCA) has questioned their transparency and the risk that they could push customers into a cycle of debt.
Are such plans, which allow staff an advance on their wages, already earned a good idea? Or are they simply another way of increasing personal cash flow issues that have arisen as a result of COVID-19 restrictions with a rise in people losing their jobs or experiencing a reduction in their personal income?
What Are Salary Advance Schemes?
Employer Salary Advance Schemes (ESAS) allow workers access to up to 50 per cent of their wages before their regular payday.
Employers sign up with ESAS providers who effectively act as a bridge between the company’s payroll department and the staff member’s bank account.
The amount an employee can withdraw is based upon wages they have effectively already earned. This may be based on the hours or numbers of shifts they have worked by when they request the withdrawal.
Are There Fees Charged by Salary Advance Schemes?
While the principle may seem entirely sound – a worker is simply asking for money they have already ‘banked’ earlier in the month – there are fees charged by the ESAS and the potential for problems in the future.
Because the salary advance is not classed as a loan, the cost is not described as “interest”. But there is a flat fee to be paid for every withdrawal, which will be deducted from the individual’s wage along with the amount of money they have already taken from their pay.
The fee charged is modest, usually, less than £2 per transaction, whether the value is £50 or £500. This low charge is largely reflective of the lack of risk to the provider that the money will be repaid. It is automatically paid from the staff member’s wage after all.
Are Salary Advance Schemes the Same As a Payday Loan?
While the principle is the same – a customer receives an amount of money that is repaid on their payday – salary advance schemes are not the same as a payday loan.
A salary advance is not a form of credit. A payday loan is short term borrowing with interest applied.
Payday loans are intended only for a few weeks, so their APR is higher than many other forms of credit. And because payday loans are often available to people with a poor credit history, they can have higher interest rates because of the risk to the lender.
Payday loans can be an expensive way of borrowing, but only if not managed properly. However, a salary advance can lead to very similar issues as a payday loan, as the FCA has recently stated.
What Did the FCA Say About Salary Advance Schemes?
The FCA recognised that ESAS could offer benefits to customers by saying they can be a convenient way for employees to access emergency funds.
But in a statement, the FCA further warned that accessing an ESAS can lead to the same problems that mismanaging a payday loan can present:
“People should bear in mind that the amount they were advanced and any fees will be taken from their next paycheque.
“So they need to be sure they can meet their outgoings and pay any expenses that might then arise.
“If there are difficulties doing this, then this might indicate a more underlying or longer-term financial problem, and a salary advance might only partially help those in this situation.”
What Are the Problems With Salary Advance Schemes?
Aside from reducing the ability of employees to cover essential bills from their next payday, salary advance schemes can cause further issues.
Taking a portion of wages early brings the potential for the worker to run short of money again the following month. This increases the risk of such a scheme becoming a cycle.
Evidence suggests that such withdrawals may not just be a simple one-off for many customers.
Research has shown that on average, users will take an advance twice a month worth around £70 each time.
Unlike payday loans, ESAS providers are not regulated by the FCA. They are also not required to perform any affordability check, unlike credit providers.
They could also trap users into relying on other forms of debt to get by. For example, a salary advance will not show up on an individual’s credit file, which means that future lenders will not be able to identify potential problem borrowing or difficulties in repaying loans.
This means that, in fact, customers may have less protection by using a salary advance scheme. Because there is no risk to the scheme provider, all of it lies with the user themselves.
There is no check carried out to ensure that individuals will be able to meet essential outgoings by repaying the advance on their wages. Moreover, because the ESAS scheme is seen by employees to be backed by their employer, this may give them a false sense of security.
The Future of Salary Advance Schemes
The FCA findings come with several recommendations, both for providers and employers.
The FCA has stated they intend to continue monitoring the situation, which means they may consider further recommendations or rules around their use in future.
Payday loans are now subject to strict rules and regulations. Some money experts are concerned that the increased use of salary advance schemes may leave customers without adequate protection and at risk of the affordability and debt cycle issues which led to increased rules around payday loans in the first place.