Charged Up! podcast: The reason behind poor credit
Episode 36 with author Rachel Schneider on financial diaries of Americans
If financial distress isn’t necessarily rooted in unemployment, then what is the reason so many Americans find themselves with poor credit and dwindling bank accounts? Rachel Schneider decided to do a field study throughout the U.S. to find out what is plaguing most people when it comes to financial distress and how families can cope with financial uncertainty.
Schneider and her co-author, Jonathan Morduch, spent a year following the lives of 235 low and middle-income families. What they document in their book, “The Financial Diaries: How American Families Cope in a World of Uncertainty,” challenges popular assumptions about how Americans earn, spend, borrow, and save – and they identify the true causes of distress and inequality for many working Americans.
Whether you’re in this financial distress, know someone in this situation or are just curious about how uncertainty really affects people, Schneider’s insights are enlightening and can perhaps stir our creativity to come up with some amazing solutions – which are happening in the financial technology space now.
So, let’s get Charged Up! about delving in to the financial diaries of Americans!
Jenny Hoff: Rachel, thank you so much for joining me today.
Rachel Schneider: Thank you so much for having me. I’m looking forward to our conversation.
Hoff: Me too. So let’s first talk about the financial diaries project. And I guess it dealt with a lot of field research that you did first. Where did this project come from and how did you conduct your research?
Schneider: Sure. So we started a long time ago. The inspiration for this project actually came right on the tail of the financial crisis, when it was clear that there was a huge layer of financial fragility that American families were experiencing that had been covered by the housing bubble and easy availability of credit. And so our funders, the Four Foundation, the City Foundation, and then later our media network really wanted to support research that would do a deeper dive into the financial lives of American families. And so they started talking with my partner in this, Jonathan Morduch, who is at the financial access initiative at NYU about replicating research that had been done internationally that he had been part of. And then I joined the team on behalf of CFSI because we really needed a local perspective. Jonathan’s work had all been international. The idea was to do a deep dive with families. So what we did is we worked with 235 families. They were in four different locations in the US. So California, Mississippi, along the Ohio border, and New York. We had field researchers who met with the families every few weeks. What was crazy, in hindsight, this is just nuts. What they try to do is gather information about every single dollar that went in and out of the houses for a year. So every dollar the families earned, spent, saved, borrowed, we collected data about was just a crazy imposition in terms of time. We’re so grateful that the families would do that.
Hoff: So they came every couple of weeks and met these families. For how long did this last?
Schneider: About a year. We wanted full 12 months cycle of data because we wanted to understand the seasonal ups and downs that people experience. We wanted to see Christmas spending. So we wanted a year. We actually started with more families than that but it was such a big time commitment on everybody’s part that families, of course we knew, would drop out along the way.
Hoff: Sure. So ultimately, it was 235 families that you collected data from?
Hoff: Did you choose them from a wide range on economic backgrounds or were they mainly all in the lower economic strata?
Schneider: The common thread was that every household had somebody in it who is working. So it wasn’t an effort to understand really deep poverty. It was an effort to understand what the lives of working Americans are like. About a quarter of the sample was roughly middle income near the area median income. About a quarter were hovering around the poverty line, and then the rest were in between.
Hoff: Okay. Were these all considered non-prime borrowers, people with low credit scores or people that had already let you know that they were struggling financially?
Schneider: That’s a terrific question. We thought about collecting credit scores. It ultimately was not viable. So we don’t know. It would be really interesting to overlay a credit score on top of what we learned. We did ask a lot of questions about credit card usage and plenty of people are dependent credit cards. It was, I think, what you’d expect from a cross section of working class Americans where some had perfectly good credit scores, some had damaged credits, and some had no credit. A lot of how I think about it is the stories of the people that I got to know. If I think about them, they run the gamut in terms of their experience with credit.
Hoff: I’m excited to talk about what your findings were because I think that there’s a lot of misconceptions out there as to why people get into financial distress. Is it their fault? Was it bad habits on their part? Is it something that they could fix? Or was it something that was little bit beyond their control? I’m sure you found a little bit of a mix of all of that in there. First of all, to answer the question as to how people get into these financial issues, is that what the purpose was?
Schneider: No. I love that you’re asking it that way. I can’t wait to dive into whatever your question is about. The purpose was really to understand people’s financial lives in an open-ended way. We did start out with some specific things we wanted to know and a lot of those were about financial services usage. So we asked for really detailed questions about like, do you pay your bills online? Do you pay your bills in cash? When I say detailed, I mean in the sense that we didn’t ask that question generally, we collected data about every transaction that happened and for each transaction, we logged how had this transaction occurred. But the reality is when we step back and thought about what this research was really about and what it could achieve, it was more about an understanding of economic life in general and the kinds of big picture trends that are affecting how families live their financial lives.
Hoff: First off, what was some of your most interesting findings when you were out there? What were you not expecting to find that you found?
Schneider: The biggest thing we’ve talked about from the findings is a story about volatility. I think this is really relevant when you think about credit cards. So we asked everybody about their income. We tracked paychecks. And what we found was that on average, people experience five months of the year where their pay from their paychecks and their variety of income was either 25% more or 25% less than their average pay. Five months of the year. I feel like I have to really emphasize it. It’s a huge amount of time. What’s even crazier is that we use that benchmark of 25% higher or lower because that’s the benchmark that’s been used in other academic research. But actually, the spikes and dips that we saw in income were 50 percent higher or lower than average. It’s a huge –
Hoff: Were they a lot of contractors or was it overtime pay? What was it that caused these kinds of fluctuations?
Schneider: The common story is the economy. For some people, that’s the case. But when we look at it statistically, the biggest driver for volatility in our research sample was change in the amount of paycheck from the same job. So what it is, I can tell through a story best. One woman we talk about in the book works at a casino and her income is really dependent on tips, and of course tips are highly variable. So that’s the phenomenon for lots of people. But then somebody else we got to know worked as a salary employee but doing tax preparation. Well, that happens in the first quarter of the year. Somebody else works at a retail store and gets a variable number of hours each depending on demand at the store. That’s because of productivity enhancements, it’s become really common for all kinds of employers to be able to flex the amount of workers that they have on site, depending on demand for their services. So that was already the case in manufacturing. It’s really the case now in retail and other kinds of service jobs. So lots of people, millions of people in our country have a steady job but not a steady paycheck.
Hoff: So what does that mean as far as their financial lives go, when it fluctuates so much, when half the year essentially they can’t really predict it?
Schneider: So many things. So first of all, it means budgeting is real-time and constant. One family I talked to and I said, “What’s your financial life like?” They say, “Well, it’s really about Sunday nights.” Because on Sunday nights every week, what they would do is sit down. That’s when the husband and the wife and his family would get their hours from their job and then they estimate their paychecks, and then they look at each of their bills and decide which bills they could pay and which bills had to be put off, on a weekly basis. But lots of people are managing their balance real-time. So we saw a lot of people who instead of going to the grocery store once a week would go every few days in an effort to spend less in each moment. They just want to hold on to cash, not overspend in any particular minute. So budgeting really changes when you have that volatility. It also gets really hard to think ahead. The energy you might otherwise spend thinking about 3 years from now or 10 years from now has to get refocused toward next week, next month, three months from now. We really see it as a cause that people are pulling their focus in to closer, nearer term issues.
Hoff: What did you find ended up disrupting their finances the most? Was it some sort of emergency like a car accident or a medical issue when suddeny that real-time budgeting gets thrown out?
Schneider: That’s the other thing that I feel like is a myth that our research starts to not quite dispel because it’s not quite a myth but adds some complexity to. It is the case that people have spikes in their spending needs, right? Car break down, health care, all the stuff you just said. But it’s also the case that spending is volatile on ongoing basis. We tend to think of spending the same way we tend to think of income like it’s going to be basically steady then maybe you get a bonus at the end of the year or conversely maybe just basically spending and something bad happens every 18 months. But the reality what we saw was that spending was just as volatile as income.
Hoff: Every month?
Schneider: Yeah, every month. And some of it is because in response to income volatility, like my income was low so I didn’t pay this bill or my income was high so I paid these back-bills that I now owed. That has a huge impact on families because then they accumulate fees. They accumulate late payments and it makes it really hard for them to plan in another way. It impacts their credit, obviously, if they’re doing that with credit cards. So, some of the volatility is what we thought of as the spending volatility as a result of the income volatility but it’s also the case that there are things that aren’t quite emergencies but are also still spikey. Christmas is a good example, the beginning of the school year, or people have birthdays, people have graduation parties. There are all sorts of moments when you might spend.
Hoff: Vacation for the family.
Schneider: Exactly. And so the word emergency always is tripping me up because there’s lots of spikes in spending. Sometimes there are unknown or unpredictable but they’re pretty common. They’re not rare.
Hoff: Did you find any families that you felt were somehow handling this volatility better than others and what were the things that they were doing that were right in a sense? Because they had their finances under control.
Schneider: It’s such a good question. A lot of it we tried to do in this work was take the stories and identify strategies that could work. The meta point, like the overarching point is that the strategies that work, they arise from when somebody knows themselves and knows how to set up a system that works for them but takes lots of different forms. One woman we got to know, when she had income spikes, she would grab those spikes and stock her pantry. So she set up that eight months’ worth of toothpaste. Will never need to buy again. But she knew as a result that if her income drops –
Hoff: She doesn’t run out of toothpaste.
Schneider: Exactly. And her freezer was stocked. A lot of people find ways to lock up their savings so that they can’t get access to it. They’re just creating discipline. But the key there is to make it sort of a weak lockup because if it’s too strong of a lockup, then you don’t want to save. It’s too scary. You can’t get the money.
Hoff: Or you don’t want to be going to a payday lender or somebody that’s going to charge you exorbitant interest for money that you actually have somewhere but you can’t access, right?
Schneider: Exactly. So it gets too scary. But if it’s no commitment at all, then it doesn’t do the job. So you see things like one woman put her savings in a credit union that was an hour’s drive from her house and had inconvenient hours and she cut up the ATM card.
Schneider: Right. It works. So, she said, “I can get the money,” but in her words, it was, “I’ll only make that drive if I really, really need it.” And some variations on those kinds of strategy. Another thing that we saw somebody do was over-withhold their taxes so that they could guarantee a big refund.
Hoff: So it was a saving plan, essentially? They couldn’t tap into that money.
Schneider: Yeah. Right. Safe with the government.
Hoff: Yeah. Instead of you getting the interest though, the government’s getting the interest. But again, it is something that if you know you have a little bit of a problem when it comes to discipline in that sense, you have to do what works for you.
Schneider: Exactly. You said it earlier. When people get into financial trouble, some of it is their own stuff, their own behavior, their own weaknesses. Some of it is external. People who have had financial trouble, they get real where the part of it sets their own weakness. We saw people going to great lengths to be able to save. We also saw people going to the same great lengths to avoid borrowing if they felt like they’ve had trouble with borrowing in the past.
Hoff: What about people that were a little bit in a financial mess? Did you see a trend as far as behaviors or actions that seem to resonate with the people that were having the most trouble financially?
Schneider: I don’t know. That’s an interesting lens. I don’t think we saw really different behaviors. I think we saw different complexities in their life. It is easier to have a smooth financial life if you have less complexity. The families that seemed to us like they had sort of figured it out for themselves, sometimes those were older people with grown children versus somebody who’s got three young kids at home. Then the level of complexity you’re managing if you have multiple source of income and kids to move around the world and jobs plus school, it is harder. But in a way, I’m not really doing either of those archetypes of families justice when I say that because the people who were older in our sample didn’t necessarily have what they needed to have saved for retirement saved. So it’s sort of in a different problem, maybe that’s the -
Hoff: They get by in the day-to-day.
Schneider: Yeah. They had a much easier day-to-day –
Hoff: But they don’t have a long-term plan.
Schneider: Not necessarily but it’s hard to see patterns of what wasn’t working for people. But part of it is we really didn’t look at it that way. We were really looking at it to understand what’s going on in people’s lives and what strategies seem to help and what are the external forces that seem to be driving it one way or the other.
Hoff: I’ve heard from a lot of different people who have a situation where maybe there’s just one person earning the money. The spouse is not earning money right now but they’re also not taking care of the kids so the kids have to go to daycare and they’ve got a lot of different expenses that they’re dealing with or they got into some sort of debt 10 years ago and they’re still trying to crawl out of it or whatever those situations are. What would you say to people who could definitely identify with these groups of people that you guys were researching for a year and they find themselves maybe in the middle income to lower income groups that are with fluctuating incomes? What would you suggest to them as far as starting to put a little bit of financial stability in their lives?
Schneider: I thought a lot about this because our research was designed mostly to be able to advise financial product developers. When we thought about the audience for this research, we really thought about the financial services industry. I work at a place called the center for Financial Services Innovation where we talk about how financial services can build financial health. So we’re really thinking about that audience. We were thinking about policy makers who have a lot of influence and whether or not financial services are designed in ways that build financial health and also obviously a lot of influence on whether or not people have the kinds of jobs that enable them to have steady financial lives or not. And yet the majority of people who often hear the research have your question.
Schneider: What do we tell the families? I found that fascinating. I know Jonathan and I, my co-author, we really had to push ourselves to think about, like what’s the personal finances like, what’s the takeaway? One of the takeaways from a personal finance perspective is you have to think about ‘soon.’ A lot of our personal finance advice is about the long term. How do you plan for far off, big goals like buying a house, retiring, getting education? But the reality is that a lot of families need to focus more on the near term on the things that are happening soon in addition to worrying about those later goals. And if they don’t worry about how to manage the ups and downs, the fluctuations of the next three months, those long term goals are really hard to achieve. And I always have in my mind, one family we got to know who really have a strong long term vision. It was near-term medical expenses and having to declare bankruptcy for that is really going to derail those long-term visions potentially. Maybe not entirely, but it makes it so much harder. So, people do need to embrace spending more energy on budgeting from week to week, on saving for soon. When you think about your savings buckets, you probably need a long term savings account whether that’s for retirement or education, whatever is your current goal. You probably need this six to eight months of spending that most personal finance advisors tell you need to put away. And then you need this additional savings bucket that’s a revolving savings account that you expect to save and then spend down –
Hoff: And you ought to tap into when that paycheck is 25 percent less or 50 percent less than it was the month before.
Schneider: Exactly. And I think the problem is because we have people cater into this idea like big emergency fund of six months. People don’t want to spend that down. Once you’ve accumulated that, you don’t want to spend it once –
Hoff: That’s for an emergency, right.
Schneider: Right. That’s for –
Hoff: Losing your job, yeah.
Schneider: Yeah. And so, you’ll see people borrow on a credit card for the month-to-month up and down instead of spending down that savings. I think that’s because of a very real human thought process which is it was really hard to set aside that savings. I’m not breaking into it.
Hoff: Yeah. That’s interesting. OK. So a key piece of advice is, while you do want to concentrate on the long term, you should be putting an equal amount of effort into short term savings and savings that you know you’re going to use the next month, doesn’t matter how much it is. If you know that sometimes you’re $500 under one month, you have that in there to make up for it so you’re not going to go to a high-interest credit card. Put it on there because you don’t know if the next month you’re going to get the money you’ll be able to pay that off in full. I like that. Important thing is if you’re in near-term savings plan that you’re not afraid to tap into when needed. It’s not this massive savings but it’s something that will help you prevent high-interest credit card debt.
Hoff: That’s great. What about when we talk about financial services and we talk about policy? If that was your initial audience, what kind of products do you think need to be out there or need to be developed or need to be showcased more to people who are in these situations?
Schneider: Really good question. I think there’s so much we can do here with really creative financial product innovation. Because this is exactly what the financial project was designed to do, is to help you move cash from one time to another time, help you smooth out your spending or come up with a useful large chunk of money. I’m really excited by things like a company called Even for example, where what Even does is to watch your paychecks overt time. When your paychecks are low, they offer you a boost. When they are high, then you repay the boost. In a way, you can think of it as a credit product in combination with a savings product. But what the key to me, and this is what we need to see from financial services, is that they’re not selling credit and savings. They’re selling stability. You pay them a weekly subscription fee, which is very different than paying interest.
Hoff: Because it’s stable.
Schneider: It’s stable. I’m paying the same amount and also with some credit cards. If you carry a balance, that’s when you become most profitable. But that’s not how Even’s business model work. And so I think that’s really important. We have to think about how to use financial services to deliver financial health, how to deliver a good outcome, and not only think about how to deliver a product.
Hoff: That’s interesting. So something like a subscription-based Even, which is this fin tech company that helps you make sure you have the exact same income every month, depending on your fluctuations that doesn’t matter, gives you financial stability to actually make a budget that you could follow, you can use, you can have a savings plan instead of every week having to kind of on the fly make a budget and not having any capacity to figure out, which goes into savings, because we might need it next week.
Schneider: Exactly. And now that we’re getting so much data, it’s such increasingly good and useful predictive analytics. There’s all sorts of variations on that theme you can start to imagine where financial services companies do more than deliver you a savings account or a transactional account. They actually help you manage your finances real-time. So the way we thought about in the book is people need the right money at the right time. But the math on that is getting increasingly complicated for everyone and yet with big data analytics –
Hoff: Let the robots do it.
Schneider: Exactly, yes.
Hoff: They can figure out how much you’re going to need every month. They can figure out what your lifestyle is like. What are your needs? What are your savings goals and everything like that? And then they can make sure you have in your account every month what you need and put it away.
Schneider: Totally. I love that. The first time I’ve heard somebody say “let the robots do it” in a way that feels inspiring and optimistic.
Hoff: Right. Because they’re not emotional about it.
Schneider: True. Exactly. I think that’s right. That was another big aha for me as an aside, how emotional money is. People are not making these decisions based on the math. They’re not. They’re making them based on emotions.
Hoff: Sure. Even “I want to be able to give my kids a wonderful vacation to Disney World and I want them to have that memory when they’re older” maybe doesn’t make financial sense but life is short and they’re going to remember that forever but at the same time then, you get yourself in debt. If the robot is controlling your paycheck, he’s going to be like, “No, you’re going to the local hotel for an overnight instead for your family vacation.”
Schneider: Exactly. And your kids will love the pool.
Hoff: They’ll have a good time anyway. What about policy-wise? I don’t usually like to talk about politics and policy here but it is interesting when you see these situations and you see these people. What policies did you guys think would be most beneficial to them?
Schneider: There’s a whole range of things. Some of it just stick with this theme of financial innovation, is about making innovation possible. This is pretty much in the weeds. The CFPB has done some work, so as the OCC where they’re trying to figure out how to encourage financial innovation while still maintaining the right level of consumer protections.
Hoff: So maybe having to lower some regulations in some sense to make these innovations possible?
Schneider: In some cases. Or what the CFPB wanted to so isn’t necessarily lower regulations but create a safe space for people to innovate work, maybe don’t lower the regulation altogether for everyone but give a company a pass to try something to see if maybe the regulation should be changed.
Hoff: Get some willing participants, almost like medical studies or something.
Hoff: So you have a little bit of a free pass that people totally know what they’re getting into, that they could end up not being a successful product but they get to be a part of something that could potentially be better and then afterwards the CFPB or whatever federal authority could decide if maybe the regulations are too severe.
Schneider: Exactly. People talk about it as a sandbox. In the U.K, they started with this idea of having a sandbox in which to practice something and see if it worked. But if you think about our disclosure for example, like financial services disclosures, they are awful. Who are reading those things? And they’re long with tiny fonts because of the regulatory expectation about what consumers will be told. So you could envision in this sandbox experimenting with easier faster larger font disclosures. Like see as a result, people actually understand better the product that they are using.
Hoff: Limit the word amount like Twitter. You can have 36 characters to let them know exactly what they’re getting into.
Schneider: Totally, which would be great. What a good experiment that would be. But companies can’t even really experiment with that easily. So there’s a lot that regulators could do to advance innovation and at the same time there are some work they have to keep doing on protections. That’s a reasonable part of their work too.
Hoff: Well, I see it’s interesting because Rachel and I are talking at a conference right now, the Emerge Conference, and it’s in Austin this year. We’re talking about digital banking and solutions for people who are the unbanked and people who need more financial solutions. I’ve talked to a lot of really interesting startup companies that are coming up with brilliant ideas of how to bridge that gap between people who can’t access credit potentially but they have either a lot of equity in their house or they have something else that they could use for leverage. One of the problems I talked about with one of the guys, the most money he’s spent has been on legal issues, trying to fit in with all these regulations in each day and to make sure that he’s following everything. What would you say is your biggest hope for the near future in the fin tech space?
Schneider: Such a good question. It is really not only fin tech but financial services more broadly. My biggest hope absolutely is that the industry changes its self-perception. Are they in the business of delivering financial services just like a product that people buy or sell or are they in the business of delivering financial health? And if we can get that mind shift, which is also a lot of what this conference is about, and we’re seeing it. We’re seeing companies say to themselves, we’re seeing senior management team say themselves, “Our company is about delivering financial well-being. We want our customers and our employees to live stable, upwardly mobilized lives to the best of their abilities.” There’s a limit to what financial services can do like our broader economy has a huge impact on whether or not people live the financial lives they want and deserve. But financial services certainly play a role.
Schneider: So my big hope is that we see that sort of cognitive shift because once you get that, you see a huge change, I think, in the way that a lot of products are designed and delivered.
Hoff: Absolutely. It’s a really alignment if interest for the banking industry or financial industries. A customer in good financial health is also a long term-customer. It’s not somebody that you have to worry about default or foreclosure or bankruptcy or any of those things.
Schneider: Exactly. And in theory, a customer who is pursuing opportunity and mobility grows into more and more of your products and services. So not only long-term, but long term-increase in value with real loyalty, with the satisfaction ratings with financial services companies, all those kinds of metrics, the trust indices are currently really low. People don’t –
Hoff: There’s no loyalty because they don’t feel like they’re loyal to them.
Schneider: Yeah. And the only reason people don’t switch is it’s hard to switch and kind of a pain and they’re not sure that there’s a better option. I think the companies that figure out how to really deliver financial wellbeing, they are going to be the ones that offer something that’s worth switching for.
Hoff: Absolutely. Finally, our show is called Charged Up! What charges you up about really discovering the true essence of financial health in America and helping come up with solutions to it?
Schneider: You know, it really is about helping other people. I have been so blessed and so lucky in my life and I just want more people to be able to experience that feeling of wind at your back and getting the support they need to lead the lives that they want and deserve.
Hoff: Absolutely. I hope that too. Thank you so much for joining us today, Rachel. Fascinating discussion.
Schneider: Thank you so much. I loved it.
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