“Underbanking”, why it’s more expensive to be poor

By Jon Scott

Abstract: There are millions of Americans who are underbanked. This article explains underbanking and the debt spiral. Lastly, the article explores ways to climb out of underbanking and the debt spiral and reach surer financial footing.

Unfortunately, there is a segment of Americans who will lose some $70,000 during their lifetime. The reason: the costs of being underbanked. Underbanked is defined as people without access to a checking account, but often use non banking services such as payday loans, pawnshops, or cash advance businesses. The extra $70,000 in costs faced by underbanked Americans is a result of fees charged by these non-banking institutions. For instance, it is not uncommon for a payday loan provider to charge $15 per every $100. While the number of underbanked Americans has steadily decreased, 5.4% of households in the US remain underbanked.

Underbanking can often lead to a debt spiral, where an individual continues to fall deeper and deeper into debt even though they are up to date with their current payments. Many times this is because payments only cover interest and do not pay down the principal amount owed. Debt spirals usually begin due to a loss of income such as losing a job, an emergency event that requires a large amount of money to cover, or simply overspending where an individual is spending more than they make. I THINK THE ARTICLE ON HOW TO PAY DEBT MADE BY RP WOULD BE INSERTED HERE

How to Solve Being Underbanked

Open a Checking Account

The first step is to open a checking account. The two most common reasons Americans remained underbanked were the inability to meet minimum balance requirements, and a lack of trust in banks. Minimum balance is the least amount of cash required to be held in the account at all times. However, there are a number of bank checking accounts that do not require a minimum balance. As far as distrust in banks, that is a real concern for the average consumer. There are many fees, beyond a minimum balance fee, located deep inside the agreement that comes with a new checking account, however many of these are avoidable.

The first is an overdraft fee, charged when you spend more than the amount in your account and the bank covers that amount. Similarly, NSF fees are charged when you spend more than what is in your account and the bank declines the purchase. Overdraft fees average $29.80 and NSF fees average $26.58. Ultimately, the only way to avoid these fees is to keep track of the amount in your checking account. Additionally, budgeting can help overspending.

Reduce Monthly Expenses

Beyond establishing a checking account, there are other ways for underbanked individuals to reduce monthly expenses. Many individuals need the money from their paychecks immediately, and cannot wait for the money to clear, that’s why reducing monthly expenses and saving money to deposit in a checking account is so important. For instance, take a look at your utility usage. Is there an opportunity to reduce your electrical, water, or gas usage? Entertainment and internet expenses are also a great place to reduce spending. If you own one or multiple streaming services ask yourself if there is the ability to bundle these services, or simply cancel one of the services you find yourself enjoying the least. For internet, shop around for other providers or check if there is a less expensive option that still meets all your internet speed and capability requirements. Additionally, some individuals may be eligible for the Affordable Connectivity Program established by Congress to provide more affordable access to high speed internet.

Establish Some Sort of Credit

Poor credit is a main reason why underbanked individuals–even after establishing a checking account–are subject to more fees than wealthier or better informed individuals. The lower your credit score, the more it costs to borrow money. A poor credit score can have a significant effect on a car payment, for example, a score of 661 will result in a used-car loan interest rate of around 5.53% whereas a credit score of 781-850 can result in an interest rate of 2.96%. Purchasing a car with a total cost of $25,000 and a down payment of $2000 over a 60 month period and a 5.53% interest rate would require a $440 car payment and a total cost of $28,379. A 2.96% would mean a payment of $413 and a total cost over the lifetime of the loan of $26,772.27– a difference of almost $1600 and more than 3 months worth of car payments.

The best way to establish credit is with a credit card. Not only do credit cards help establish credit if used correctly, but they also provide reward points that can be redeemed for additional cash or other helpful purchases that put money back into your account. However there are other options for those who are not yet able to open a traditional credit card.

Steps for Climbing Out of Underbanking

1. Open a no fee checking account

2. Reduce monthly expenses in order to save money. These savings will be deposited into your checking account

3. Deposit money into your checking account continuously

4. Open a credit card or use a credit building alternative

5. Pay with all or most of your expenses with a credit card

6. Repeat steps 2, 3, and 5 before eventually saving enough money to open multiple credit cards and start investing in income generating investment vehicles