Addressing the Five Implementation Challenges of Payroll-Linked Lending

By Arun Agrahi, Highline CTO

While payroll-linked lending has been around for decades, its impact as a payment method is still being realized. Traditionally, the implementation process has been complex, which has prevented it from becoming scalable in a meaningful way. The level of effort required to link to a single employer, let alone thousands, has meant that payroll-linked lending remained available to only a small portion of employees, mostly in the public sector. What’s been missing is a way to effectively create this scale. However, now Highline is meeting this challenge.

Borrowers and lenders can both benefit from payroll-linked lending. For lenders, the business case is powerful, as it can:

  • Reduce missed payments by up to 66% compared to ACH
  • Increase a borrower’s FICO score by roughly 100 points for determining creditworthiness
  • Drive up to 25% origination growth
  • Cut expected default rates by half

With automatic payroll-linked payment, loss rates are reduced two-thirds in comparison to ACH based payment. This advantage applies across all FICO score levels.

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Source: credit bureau benchmark for unsecured term loans

For borrowers, this means access to credit they did not previously have or incentive-based offers, such as a lower rate for paying through the payroll-linked option. This will help millions of consumers improve their financial position, first with lower borrowing costs, and subsequently, with potential increases in their credit scores due to timely loan repayments.

The current economic environment could present an ideal opportunity to adopt and test payroll-linked lending. With today’s rising inflation and high interest rates, many people will unfortunately experience financial difficulties. This is further exacerbated by cost of living increases, especially in many key areas that directly impact consumers, such as food, fuel and housing. Combined, this means many consumers will need to borrow more than ever, yet borrowing will become harder and more costly.

What’s more, many consumers will also have trouble maintaining their existing expenses, which can lead to more failed payments and defaults (even with automatic payments through ACH). This dilemma increases lenders’ risks of loss while creating a negative spiral for consumers. If one ACH payment fails, the subsequent overdraft fee could then cause the next one to fail too. Not only will the consumer fall behind on their loan, but they may also find they don’t have the funds necessary to pay other expenses.

However, with a payroll-linked loan payment, the lender gets paid automatically, and the borrower stays current on their loan payment, avoiding the risk of overdraft fees. 

Adoption Challenges for Payroll-linked Lending 

Although payroll-linked lending has been available for decades, most lenders and borrowers are unaware of its advantages. Borrowers haven’t had the chance to learn simply because they’ve never been offered the option. Lenders are in a similar situation since using payroll history in credit decisioning or receiving payments automatically from payroll linking hasn’t been a common practice.

Even if a borrower or lender knew about it, historically payroll-linked lending was difficult to set up, operate, and keep compliant for several reasons – payroll schedules don’t line up with bill due dates; the amount due can vary each month; borrowers change jobs or have income gaps; loans are paid off, but borrowers don’t stop the automatic payroll-based payment. Regardless of the specific reason, they can all create operational and compliance challenges for lenders.  

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Let’s look at these in detail.

1. Regulatory Hurdles

Both loans and payroll are covered by a combination of state and federal regulations. While payroll lending has operated safely for many years, there are certain requirements that have proven challenging for lenders to meet, including issues related to the Truth in Lending Act (TILA), the Equal Credit Opportunity Act (ECOA), and state grace periods and frequency laws. For example, TILA requires an accurate forecast of cost based on payment schedule. However, with payroll schedules varying anywhere from weekly, to semi-monthly, it can be exceedingly difficult for lenders to provide an accurate forecast as to when a payment will be made from payroll.

Under ECOA, lenders cannot discriminate against consumers from certain protected classes including receiving government benefits for income, like Social Security. Since many of these payments can only be automatically deposited into one account, lenders have not been able to offer recipients the opportunity to use their income rather than their bank account for payment. What’s more, if the lender were to offer better terms or expanded credit access to those paying through payroll, it could result in discrimination.

State regulations can create challenges due to a mismatch between payroll dates and the loan’s first payment date or monthly repayment schedules. For example, many states require a minimum gap between a loan’s origination or purchase and its first payment. Because payroll-linked lending is established at the time of origination, a payroll date falling within that gap can run afoul of these regulations. Similarly, payments are applied biweekly, it can violate a monthly repayment schedule requirement.

However, Highline is structured to address these and other regulatory hurdles. The platform automatically calculates how much money must be allocated from each paycheck to meet the loan payment, regardless of the payment or loan schedule. Highline can also manage allocations regardless of how many direct deposit “slots” are available. The platform will allocate funds for a loan payment and direct the balance into the consumer’s checking account as usual. Furthermore, the platform is built to automatically manage state-specific rules like minimum first payment periods and repayment schedules.

2. Varying Pay Cycles

As mentioned, the gap between monthly payment requirements and non-monthly payroll cycles has been a major challenge for payroll-linked lending. Even slight differences between the day a customer is paid each month and the day the payment is due can cause big problems.

Unexpected payroll dates can also present an issue. If a company has a biweekly payroll schedule but issues bonuses or commissions on an off-week, the lender could receive an excess payment from the borrower. Not only does this require a process to return those funds, but it could also create a negative customer experience, especially if those bonus funds were earmarked for an immediate expense. 

Highline’s platform knows the anticipated payroll schedule and uses it to calculate the correct allocation required from each paycheck. It also knows when an extra payment is received from an unscheduled payroll, automatically routing the extra payment to the consumer’s checking account on the same day it’s received. Even better, this can be done without bothering the customer.

3. Handling Excess and Insufficient Funds

Another challenge for lenders is receiving excess funds from an overpayment. How do you quickly and efficiently return those funds to the borrower?

This can be a problem both over the course of loan repayment as well as after the loan has been repaid in full. Returning funds is a costly operational nightmare, and the potential reputational issues are not trivial.

While excess payments are a burden, insufficient funds can be even worse for lenders. Payroll deductions can fail for several reasons – the borrower changes employers; the borrower removes the allocation; the borrower may have a brief unpaid leave or a week in which income is not sufficient to fulfill all the scheduled allocations. 

When a lender isn’t aware of insufficient funds until after a payment has been missed, both the lender and consumer can suffer. Late fees and increased interest can further exacerbate the borrower’s difficult position. Credit reporting processes could also be automatically triggered, creating a negative status that will affect the borrower’s access to credit far into the future. 

The lender can be in a much better position to help the borrower and become a trusted partner in achieving their goals if they know about an upcoming underpayment ahead of time and can then proactively reach out to them. Hardship programs, payment arrangements, or a payment holiday are all options that can keep the borrower actively involved with their loan payment and reduce the risk of loss.

The approach a lender takes to address the insufficient payment and its ability to do so quickly may be quite different depending on the situation. For example, in a payroll-linked structure where the lender has a direct relationship with the employer, if the borrower changes employment it is not likely the borrower will have an option to transition the payroll-linked payment unless the new employer is also connected to the lender. However, in a payroll-linked structure where the lender works with the customer and their preferred payroll platform without employer involvement, the borrower can switch payment to the new employer without any disruptions.

Because Highline’s platform knows when an allocation is expected from payroll, it also recognizes when one hasn’t been received. Through our webhooks, we notify lenders as soon as we learn of a potential shortfall. The client portal has a pay history tab that shows this information for clients who have not implemented the webhooks. 

Highline’s platform also provides access to multiple payroll platforms and employers, making it much more likely a borrower can update their payroll credentials and continue their payroll-linked payment with a new employer. An enrolled consumer can change their payment from one employer to another by logging in with their new payroll credentials. Highline’s platform is designed to accommodate the employer change whether the payroll schedule remains the same or changes.

4. Multiple Sources of revenue (or Employers)

Many people have multiple jobs, whether full, part-time or a combination. For them, a payment-to-income ratio calculated off just one job would mis-state the level of burden. As a result, a customer with sufficient overall income might be denied a loan because no one source shows a sufficient level of income. Accessing income from all employers (or other forms of income such as social security) in one view is a complex challenge. This is especially true in a payroll-linked structure where the lender has direct relationships with employers and depends on them for the income verification. A consumer could login to multiple payroll platforms, but the information from each would be independent of the others and managing a loan in this way is likely too complex for both the consumer and lender.

Highline works in a payroll-linked structure where the lender works with the customer and not the employer. This is across multiple payroll platforms, providing access to all a consumer’s sources of income – both current and future – displaying this information in a unified, complete view for lenders.

5. Varying Direct Deposit Arrangements

Employers and payroll systems often limit the number and structure of direct deposits that can be made. For example, some may only allow a percentage or a specific dollar amount but not a combination of the two. While specific dollar amount allocations work well for bill payment, percentage-only allocations are difficult to set up in an appropriate, compliant, and operationally efficient way. Calculating a percentage equal to your monthly loan payment is challenging, even when each paycheck is the same. If the income varies by paycheck, this becomes near impossible. The fixed percentage would either collect too little or too much, creating a need to collect or return the difference.

Highline’s platform is designed both to accept payments and to return excess amounts to a consumer’s bank account. Therefore, it can work with any limitations set by an employer or payroll provider. For example, if the payroll platform has limited direct deposit “slots” and cannot support another allocation for a new loan payment, Highline can handle routing funds to billers and the consumer’s bank account. Highline can also accept a percentage of the paycheck over the payment amount and route the excess to the consumer’s account.

Overall, accommodating these challenges is complex. From a technical perspective, it’s a difficult engineering problem fraught with regulatory and operational risks. For the customer, it can easily cause a negative impact on their experience, damaging future relationships. Building the technology and processes to address these challenges can be time consuming. Additionally, in a payroll-linked structure where the lender works with employers, securing those relationships is its own heavy lift.

The Solution

More and more lenders today are understanding how payroll-linked lending works to reduce loss rates. They recognize the benefits and want to make it available for their customers, but they also know that setting up the processes can be challenging. 

That’s where Highline comes in. 

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Highline solves the numerous engineering challenges for getting all the pieces right. The open banking movement has further fueled the development of payroll APIs which allow data platforms to aggregate employment and income data from multiple employers and establish new payroll allocations, all based on consumer permissions. Highline takes advantage of this data to:

  • Calculate the allocation required from each paycheck to meet the lender’s payment schedule, no matter what payroll schedule.
  • Accept the full paycheck, a percentage, or a specific dollar amount – allowing processing of payments for those, like Social Security recipients, whose payment can only be deposited into one account.
  • Return excess funds to the consumer, including those collected during the grace period before the first payment date. This solves multiple problems:
    • Compliance with state regulations governing the first payment date.
    • Consumers who have limited slots to which their income can be allocated.
    • Payroll systems that only allow percentage allocations.
    • Bonus and commission payments outside the regular payroll schedule. 
  • Know as soon as an expected allocation isn’t received and notify the lender so they can address the shortfall proactively.
  • Direct funds to a sponsor bank FBO payment account where they remain under the direction of the consumer until sent to the lender.
  • Work across multiple employers and payroll providers so payroll-linked lending can be offered to most consumers.

We do all of this within the lender’s own experience. With Highline, the borrower doesn’t need to leave the application flow to set-up the payment. Instead, they can complete it directly from within the lender’s own site or portal, making it fast, simple and seamless to introduce payroll-linked lending. 

By working with Highline, lenders can reach more borrowers quickly and effectively, as we’ve already done the hard engineering to integrate with payroll and solve the major pain points. We built Highline for innovative leaders in lending and payments. If you’re looking for creative ways to expand your customer base and improve their experience, then we want to talk to you!

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