Who Is Considered “Low-Income”?
While this article discusses issues related to people on the lower end of the pay scale in a general sense, the term “low-income” has an official definition under the U.S. Department of Housing and Urban Development (HUD). The designations of “low-income” and “very low-income” are specific figures updated each year.
These figures adjust for the number of people in a family and vary by location. Limits are typically set at 80% and 50% of the area median individual income, according to HUD.
Due to varying costs of living in different parts of the country, there are large discrepancies between areas in who is considered low-income or very low-income.
For example, in Onslow County, N.C., $56,200 is considered low-income for a family unit of four, and $35,150 is considered very low income. In San Francisco, the low-income threshold for a family of four is $148,650, and $92,900 is considered very low-income.
Low-Income Americans Face Significant and Unique Financial Challenges
While many people struggle with saving money, it is especially tough for people with smaller incomes, said Signe-Mary McKernan, PhD Economist and Vice President for the Center on Labor, Human Services, and Population at the Urban Institute.
Those barriers extend beyond simply having less money to save. Several other factors make saving money an uphill battle for Americans on the lower end of the pay scale.
Living Expense Increases Have Outpaced Wage Growth
Over the last decade, Americans have seen substantial increases in the cost of housing and other living expenses. However, wages have not increased at a similar rate over the same time.
According to consumer price index data from the U.S. Bureau of Labor Statistics, housing costs have increased by 44.2% since 2013, greater than the overall price index increase of 32.6% over the same time.
Meanwhile, median wages have increasde only 12.1% since 2013.
Together, these trends have added substantially more to the cost-of-living side of the HUD equation than the income side. While everyone pays higher costs for housing and other essentials, these price increases cut into a larger percentage of the budget for lower-income Americans.
Low-Income Americans Tend To Pay More for Loans
Income is explicitly not a direct factor in how credit scores are determined. However, a study by the Federal Reserve in 2018 found that there was a “moderate correlation” between the two, with people making more money tending to have higher credit scores.
Credit score is the single most determinant factor in the annual percentage rate (APR) lenders offer to borrowers. Borrowers with lower credit scores pay higher interest rates than those with higher scores. As a result, those with lower scores end up paying significantly more for loans, including mortgages, auto loans and credit cards.
For example, take a five-year, $25,000 personal loan. A person with a high credit score may pay a rate of 9% – yielding a monthly payment of $518.96, according to our personal loan calculator. Someone with a low credit score might pay 17% for the same loan, resulting in a monthly payment of $621.31.
Predatory Lending Can Set People Back Financially
Payday loans and similar products offer people an opportunity to borrow relatively small amounts of cash outside of traditional lending institutions. While this money can help cover bills, small emergencies and other such expenses, they come with high fees and interest rates that make them far more expensive than loan products at mainstream financial institutions.
A standard two-week payday loan with a $15 fee for every $100 borrowed is the equivalent of a nearly 400% APR, according to the Consumer Financial Protection Bureau. Meanwhile, the typical APR on a credit card ranges from about 12% to 30%.
Because of their financial status, lower-income people are more likely to need these alternative sources of financing. Without enough income to recover financially, taking on the cost of these loans can put people further in debt and make it more difficult to achieve financial health.
“Buy Now, Pay Later” Has Added Another Pitfall
In recent years, a new type of financing generally known as “buy now, pay later” (BNPL) has grown in popularity, especially for online retail. This financing option, sometimes known as a “pay in four” arrangement, often offers “interest-free” financing within a certain period.
However, many of these companies’ offerings do charge interest, and these loans can come with high interest rates – up to as much as 36.99% in some cases.
A 2023 study by the CFPB found that 17% of people surveyed reported using a BNPL service in the year between February 2021 and February 2022. The study found that people with annual incomes between $20,000 and $50,000 — many of whom qualify as “low-income” under the HUD definition — were the most likely to use such services.
The “Poor Tax” Is Real and a Substantial Obstacle
Higher interest rates and opportunistic lending are two of the many factors that disproportionately affect lower-income Americans. These costs, and others like it, are sometimes referred to as the “poor tax.”
Many of these costs are abstract in nature, such as the effects of diminished health outcomes and fewer educational resources. However, many of them are much more direct and immediate.
For example, people with lower incomes are also more susceptible to charges from financial institutions such as overdraft of insufficient funds (NSF) fees. The amount of these fees varies by institution, but according to the Federal Deposit Insurance Corporation (FDIC), they can reach as high as $35 per instance.
Even one such fee can have a significant impact on a low-income budget, but institutions can charge an NSF for each transaction that occurs without sufficient funds. This means account holders can rack up multiple fees in a short period of time.
Experts Say Government Policy is Geared Towards Wealthier Individuals
Some of the obstacles that low-income Americans face are structural in nature.,Government policies tend to benefit people with higher incomes more than those on the lower end of the spectrum, said Dr. Michael Sherraden, George Warren Brown Distinguished University Professor at Washington University in St. Louis.
“Assets accumulate, in large part, due to social policy,” he said. “Policy has been structured to enable wealthier people to accumulate assets — such as home mortgage interest tax deduction, tax deferrals for retirement savings, lower capital gains tax rate, while penalizing the poor for accumulating assets with policies such as asset limits on social benefits.”
McKernan of The Urban Institute agreed that U.S. policy tends to benefit higher income groups.
“The federal government spends billions of dollars annually to support long-term asset-building through programs like the mortgage interest deduction and preferential tax treatment of retirement savings, but families don’t benefit from them equally,” she said. “Because these subsidies go through the tax code, the subsidies primarily benefit high-income families who have substantial savings already, leaving out people with lower income.”
Saving Money on a Smaller Income is Difficult, but Possible
These barriers can make saving money a challenge for people with lower incomes. However, McKernan said that while the obstacles between low-income households and saving are a challenge, they are not insurmountable in many cases.
“A common misconception is that people who are poor or have low incomes can’t save,” she said. “Evidence from savings programs and research shows they can.”
McKernan and the other experts we spoke to for this piece provided some steps for people with smaller incomes to start building their savings.
Make a Plan and Stick To It
Creating a budget is one of the first financial health steps recommended for people in any income class. But for people with less room for error in their household budget, having a plan for expenditures can be even more useful.
“My first suggestion would be to create a few goals,” said Andrew Waldum, associate professor of practice, personal and family financial planning at the University of Arizona Norton School of Human Ecology. “This can be harder to do than it seems, especially if a person feels stuck in the place they are at.”
After creating that budget, follow it consistently. Waldum said that people who are starting to save on a lower income should expect the process to be slow, especially at first.
“The focus should be on small, incremental steps that move toward goal achievement, such as paying off a debt — then another and another, increasing job skills, working to live within one’s means with the help of a budget and even an accountability partner,” he said.
“Identifying one thing to start saving for and identifying a path forward to get there. These are just some examples, but having some goals is where it all starts.”
Seek Free or Low-Cost Education and Support
People who can afford fees for financial advisors, money managers and others benefit from having the advice and perspectives of educated professionals. While private services may be out of reach for people on smaller wages, these people may have free or low-cost options available to them.
“It might be beneficial to work with a financial counselor or financial literacy professional that offers pro bono work or through a community service organization to help develop two or three solid goals,” Waldum said.
In addition, many credit unions offer free financial counseling and planning services. People on a limited budget can also educate themselves through free online financial literacy courses on websites such as Khan Academy.
Find Additional Income and Cut Expenses
The basic math is that to save more money, you have to find more money to save. There are two ways to do that: make more money, or spend less of it. Waldum says that for people trying to build financial health, both are important – if manageable.
“I would look for ways to encourage additional income potential,” Waldum said. “At the same time, I would encourage closely looking at every expense category to see what options might be available in terms of saving money.”
The growth of gig economy jobs that don’t require a regular time commitment has opened up more options for people seeking a side hustle to bolster their incomes. These sources of additional income tend to be relatively easy to join and leave as needed.
Finding ways to cut expenses can be a challenge, especially for people who are already scrimping. But as Waldum said, the focus should be on small, incremental steps. Services such as subscription trackers can help find opportunities to cut a few dollars each that can add up to more substantial savings.
Build an Emergency Fund
The financial experts we spoke to named having an emergency fund as a critical savings milestone. Emergency funds provide some cushion in the event of the unexpected, reducing the need to turn to high-interest options like payday loans to cover expenses. McKernan said that not having an emergency fund greatly increases the risk of financial problems.
“A lack of emergency savings means any health or other living related issue that comes up is a major issue from a financial standpoint,” she said. “As little as $250 to $750 in emergency savings can help.”
Save Money Wisely
Once people do start to build savings, where those savings are kept can make a big difference. Standard savings accounts often offer less than a 1% annual percentage yield (APY), but many banks and credit unions offer high-yield savings accounts with APYs around 5%. McKernan said that finding the right institution and account for saving money is key, and that there are resources to help people find those accounts.
“Get a safe, affordable bank or credit union account,” McKernan said.
McKernan added that it is also important for people to continue to contribute regularly to a savings fund, even after reaching a milestone. She suggested setting up one’s accounts to put money towards savings for them.
“Automate savings by automatically transferring money into a savings account each month,” McKernan said.
Low-Income Savings Strategies: Play the Long Game
Saving money isn’t easy for most people. But for people with lower incomes, additional obstacles like opportunistic lending practices and increases to living expenses that outpace increases in wages make saving an even bigger challenge.
However, while saving money is especially difficult for people in lower income brackets, it is not impossible. The experts we spoke to stressed the importance of setting and achieving small goals. Waldum said that recognizing reaching those goals is also critical.
“Even if the person can get a few hundred dollars saved, that is a huge accomplishment,” he said.
Methodology
To provide readers with a comprehensive picture of the obstacles people face when trying to save money on smaller incomes, we spoke to experts in the field of personal finance and researched federal data.
Our sources include:
- U.S. Bureau of Labor Statistics, Consumer price index: All items, 2013 – 2023
- U.S. Bureau of Labor Statistics, Consumer price index: Housing in U.S. city average, 2013 – 2023
- U.S. Bureau of Labor Statistics, Median usual weekly real earnings: Wage and salary workers: 16 years and over, 2013 – 2023
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