The Front Lines of Financial Defense: Managing Financial Emergencies in Low-Income Households

Background: Financial shocks, which are large and irregular expenses or drops in income, are common in US households. To cope with these shocks, LMI households may turn to short-term credit. These loans may further de-stabilize household finances in the wake of a financial shock. This study seeks to fill two important gaps in research. First, little is known about how LMI households prioritize different ways of coping with shocks, and whether these priorities vary based on household demographic and financial characteristics. Second, a gap in the research evidence exists concerning how varying amounts of liquid financial assets affect the likelihood LMI households turn to high-cost coping responses, such as the use of payday loans.

 

Method: This study links administrative tax data from a low- and moderate-income (LMI) tax filing platform with a survey of LMI tax filers. In this survey, we first asked LMI households what resources (e.g., friends and family, checking or savings accounts, payday loans, etc.) they would use to cope with an unexpected financial emergency, and then asked them to specify the order in which they would use these resources. Using these data, we first descriptively outline the types of resources available to LMI households and examine how these vary by ethnicity and asset levels. Subsequently we employ logistic regression to examine how a wide array of demographic and financial characteristics contribute to the probability that LMI households will rely on high-cost resources like payday loans, title loans, account overdrafts, and pawn shops.

 

Results: First, we find that while strong majorities of LMI households said they could rely on friends or family in an emergency, fewer than half of these households indicated that they could rely on mainstream financial resources like bank accounts, cash, or credit cards. In a multivariate analysis controlling for a wide array of demographic and financial characteristics, we find interesting relationships between ethnicity and the reliance on high-cost resources. Even controlling for asset levels, black and Hispanic households were significantly more likely to report relying on payday loans (odds ratio = 1.79 and 1.48, respectively; both p<0.01), while Hispanic households were more likely to report relying on title loans (OR = 1.37; p<0.05). Interestingly, white households were more likely to report relying on pawn shops than were other groups.

We also find interesting relationships between asset ownership and the use of high-cost resources. In examining the rate of high-cost resource use across quartiles of asset ownership (holding other factors constant), we find that reliance on payday loans and account overdrafts declines linearly with asset levels, while pawnshop reliance exhibits a quadratic relationship with assets. Use of title loans is relatively insensitive to assets.

 

Conclusion: It is clear from this paper that reliance on high-cost payday lenders differs by the ethnic background and access to resources of LMI households. Given the potential for high-cost lenders to create financial instability in these households, policies and programs should target liquidity-enhancing efforts in these vulnerable populations.