Pathways to Economic Stability: The Role of the Use of Alternative Financial Services

Consistent with the social work financial capability paradigm, consumer well-being is the ultimate goal of financial interventions and research. Previous research has found that financial literacy promotes desirable financial behaviors and that such behaviors enhance consumer financial well-being. No prior study, however, has examined how financial literacy affects low- and moderate-income consumers’ use of costly alternative financial services (AFS) that could threaten financial solvency and how the use of AFS affects financial well-being. The primary purpose of this study is to examine the determinants of household economic stability.

This study developed a hypothesized model that financial behaviors and AFS mediate the relationship between financial literacy and economic stability. Using a nationally representative sample of 25,509 households from the 2012 National Financial Capability Survey, structural equation modeling (SEM) with maximum likelihood estimation was utilized to test the model. The model consisted of 10 observed variables that measured three constructs: self-assessed financial literacy, AFS use, and economic stability. Financial literacy was measured by three observed variables (overall financial knowledge, dealing with financial matters, and math skills). The use of AFS was measured by five observed variables (auto title loans, payday loans, refund anticipation loans, pawn shops, and rent-to-own stores). Economic stability was measured by two observed variables (difficulty to cover expenses and pay bills and having too much debt). Financial behavior, lastly, was measured by composite scores of experiences of credit cards.

To test the model, the measurement model was first tested to assess how well the three constructs were represented by observed variables, using confirmatory factor analysis (CFA). Then, the structural model was tested. The following indices were used to evaluate the goodness of fit of the model: χ² figure, goodness of fit index (GFI), adjusted GFI (AGFI), compared fit index (CFI), normed fit index (NFI), and the root mean square error (RMSEA). Bootstrapping estimation analysis was employed to test the significance for the mediating effect of use of AFS.

The SEM analysis showed robust goodness fit indices for the model of economic stability (χ² = 3628.064, p =.000, df = 40; GFI = .975; AGFI = .959; CFI = .935; NFI = .934; RMSEA = .059). The results show that: (1) Financial literacy leads to desirable financial behavior (β = .28, t=38.533), improves economic stability (β = .25, t = 30.083), and discourages the use of AFS (β = -.20, t = -23.211); (2) Desirable financial behavior improves economic stability (β = .23, t = 33.154), but use of AFS has negative impact on economic stability (β = -.25, t = -29.822); and (3) Financial literacy has significant indirect effects on economic stability via financial behavior (β= .066, p < .01, 90% CI .062, .070) and AFS (β= .060, p < .01, 90% CI .054, .065), respectively. The findings reveal that, to enhance low- and moderate-income consumers' economic stability, community-based financial education programs should encourage consumers to engage in desirable financial behaviors and to discourage use of AFS. Regulatory AFS policy implications will be discussed.