The Cost of Being Unbanked: Hundreds of Dollars a Year, Always One Step Behind

Banks may cause their fair share of headaches, but not having access to one is even worse for your financial health. Without access to a financial institution that offers basic services such as free check cashing and loans with reasonable interest rates, unbanked consumers rely on expensive alternative financial-service providers to cash checks and take out money orders. The accompanying fees cost these households hundreds of dollars per year.

On top of the high day-to-day costs, not belonging to a bank or credit union has harmful long-term effects. Unbanked households, which the FDIC defines as those that don’t have an account at an insured institution, can’t use savings accounts to build emergency funds and can’t turn to time-saving tools for transactions such as paying bills and transferring money.

“The traditional banking system remains beyond the reach of millions of Americans," says Sean McQuay, NerdWallet's banking and credit expert. “While it might seem impossible, using a bank account can be the first step in breaking the cycle of living paycheck to paycheck, thus paving the way for financial freedom.”

More than one-third of households that don’t have a bank account say the main reason is that they don’t have enough money. The average post-tax income of such households is just $18,203, according to NerdWallet’s analysis of data from the Federal Deposit Insurance Corp. The high fees associated with alternative financial services only make matters worse.

But cheaper services are available, and taking advantage of them can help people reduce unnecessary expenses.

Key findings

• The average annual cost of not having a bank account is $196.50 for people who use a prepaid debit card that features direct deposit. That figure jumps to $497.33 if the card doesn’t offer direct deposit.

• People who deal only in cash face average annual costs of $198.83 for check cashing and money order services.

• With approximately 9 million unbanked households in the United States, down from 9.5 million in 2013, the aggregate annual cost to these families is between $1.8 billion and $4.5 billion.

• Not having a bank account forces people to use alternative financial services; unbanked consumers are about six times more likely to use costly check-cashing services.

Transacting ‘off the grid’ is expensive

“In many respects, you can equate the needs of unbanked households with those of banked households,” says John Thompson, senior vice president at the Center for Financial Services Innovation, a nonprofit financial services consulting firm. Certain transactions need to happen, but for unbanked consumers, they don’t happen through a bank, Thompson says. And that’s where they get expensive.

Take cashing a check, for example. When done through a bank or credit union, the task is as easy as it is cheap. But that convenience vanishes if you don’t belong to a traditional financial institution, and the alternative can be hair-raisingly expensive.

Check-cashing businesses typically charge between 1% and 10% of a check’s value, and that means unbanked consumers who don’t use a prepaid card that offers direct deposit pay an average of $182.03 per year just to access their money, according to NerdWallet’s analysis of FDIC data and assuming a fee of 1% of the check’s value. People who don’t have bank accounts are about six times more likely to use check-cashing services than people who do.

“Relying on services like check cashing and money orders is expensive, and it’s those Americans who can least afford these fees and inconveniences that find themselves unbanked,” McQuay says.

In lieu of checking accounts, some people use prepaid debit cards. These are available at grocery stores and other retailers like Target, Walgreens and Wal-Mart. This type of plastic is fairly uncomplicated: Users can spend only the amount of money they have loaded onto the card.

Checking account costs

NerdWallet-recommended accounts, which have lower overdraft fees and no monthly charges, cost customers around $30 annually. The average checking account costs customers about $150 per year, when factoring in monthly maintenance charges and two overdraft fees.

However, prepaid cards tend to be more expensive than standard checking accounts, costing users an average of either $179.70 or $298.50 per year, depending on whether the card comes with a free direct-deposit service. If it doesn’t, users face steep cash-loading fees. Also, prepaid cards typically have either monthly fees or per-transaction costs, along with ATM withdrawal fees.

A person who uses neither a checking account nor a prepaid card faces average annual fees of $198.83 for check cashing and money order services.

On top of their costs, prepaid cards have other shortcomings. People can’t use them to build credit, and federal law doesn’t require prepaid cards to offer fraud protection, as they do for standard debit cards. That said, networks like American Express, Discover, MasterCard and Visa typically provide a certain number of purchase protections, although this won’t cover ATM and some online transactions.

What’s more, most checking accounts are backed by the government, which means account holders wouldn’t lose any money, up to $250,000, if the institution went bankrupt. People who use prepaid debit cards get this kind of protection if their card is issued by a bank, but even then, they may not get all of their money back. If they got their plastic from an issuer that’s not insured by the FDIC, which is fairly uncommon, the issuer’s rules determine the level of protection and whether they’d be reimbursed.

Indirect costs take their toll, too

The pitfalls of not having a bank account go beyond the high costs of alternative financial services. For one, not belonging to a bank takes extra time. Unbanked consumers who don’t use prepaid cards don’t have access to the many conveniences that come with online and mobile banking, such as automatic bill pay and free money-transfer services. Prepaid cards may come with these services, but they usually aren’t free, unlike those offered by banks and credit unions.

“If you don’t belong to a financial institution, you can’t bank on your time,” Thompson says, adding that this may force people to miss work, hurting their paychecks. If people have to travel to take care of money-related chores, they incur transportation costs, too, he notes.

Not being able to use standard banking products hurts people in other ways, too. A bank gives people access to tools that can help them maintain or improve their financial health, such as savings accounts, certificates of deposit and secured credit cards. These can, for example, help them create an emergency fund and build credit, which reduce the need for costly payday loans.

The median amount borrowed from payday lenders is just $350, according to a 2013 report by the Consumer Financial Protection Bureau, a sum that people who belong to a bank or credit union could build with a savings account or use a secured credit card to cover. That would allow them to avoid predatory loans, which have median interest rates of around 300%.

With savings accounts and secured cards, it becomes easier to maintain healthy credit. And the cost of borrowing is much less; the most popular secured credit cards typically have interest rates around 20%.

“We have systems that allow us to have some way of generating data about people’s past credit behavior,” says Gregory B. Fairchild, associate professor of business administration at the University of Virginia Darden School of Business. “Absent those data, the very real cost that people face is that they’re always a risk.”

“Everyone’s a risk,” he says, but the risk for people with no credit history “is highly uncertain.”

And that risk can have a trickle-down effect into other areas of people’s lives, harming their ability to take out auto loans, get credit cards and even start a business.

Without a credit history, small business owners have a harder time getting lines of credit, says Tara Robinson, chief development officer at Mission Asset Fund, a nonprofit that facilitates loans and other financial products for previously underserved families. Not having a credit history can therefore limit people’s earnings potential, she says.

“You kind of get stuck before you can even get started,” Robinson says.

Better options for unbanked consumers

If you don’t have a bank account, it may seem as if expensive alternative financial services are your only options. But that’s not necessarily the case. Here are a few strategies worth pursuing.

Take advantage of second-chance checking: If you have had a check bounce or closed an account before paying a bank fee, you may be listed in ChexSystems, a consumer reporting agency. A negative file is often all it takes for a bank to turn down your application for a new account.

But some financial institutions offer second-chance checking accounts. These accounts eliminate the need to use check-cashing services and money orders, the latter of which cost unbanked consumers about $17 per year. These products are available to people listed in ChexSystems and can be used to re-establish a clean banking history. Once you’ve managed to do that, consider opening a savings account to help you build and better manage your emergency fund. To open either type of account, you’ll need to provide proof of identification, and may be asked to make an initial deposit of anywhere from $10 to $100.

» MORE: Second-chance checking accounts across the U.S.

Get a secured credit card: With a secured card, you put down a deposit, typically at least $200 or $300, which you can then borrow against. After using a secured card responsibly for about one year, you may be offered an upgrade to a standard credit card.

Perhaps more importantly, you will have improved your credit score in the process, thus becoming more attractive to lenders. That’s assuming, of course, that you make your monthly payments on time and in full.

» MORE: NerdWallet’s best credit cards for bad credit

Join a lending circle or work with a small community lender: Borrowing money and repaying it on time improves your credit, and taking out traditional loans from banks and credit unions isn’t your only option. Mission Asset Fund, Robinson’s employer, facilitates and oversees lending circles, which offer a special type of zero-interest loan.

“Each loan is typically around $1,000,” Robinson says. “You have 10 people come together, and they each put in $100 every month, with one person getting the loan each month. It rotates around until everyone gets the loan.”

Like most organizations that oversee lending circles, Mission Asset reports repayment behavior to credit bureaus on a monthly basis. People with nonexistent credit who make their payments on time can improve their scores to about 650 after only six months, Robinson says.

“It’s an opportunity for folks with no credit scores to build credit quickly and for those who have damaged scores to help start to rebuild them with a positive line of credit,” she adds.

Check to see if there’s a local community lender or nonprofit in your city that facilitates these types of loans or similar financial services.

» MORE: Payday loans: dangers and best alternatives

Joining the financial mainstream

From depositing checks to using savings accounts, the reasons people turn to banks may not sound particularly exciting. Ultimately, though, banks serve as important pillars in families’ financial lives. If you don’t have access to one, managing your money and taking care of daily financial chores can be harder and almost certainly will be more expensive.

That’s what makes second-chance checking accounts, secured credit cards, lending circles and community lenders so valuable. They provide families with access to traditional financial services that they would otherwise miss out on, thus paving the way to a more secure financial future.

NerdWallet data analyst Sreekar Jasthi and writer Spencer Tierney contributed to this study.

METHODOLOGY

To calculate the average income for unbanked households, we used data from the 2015 FDIC National Survey of Unbanked and Underbanked Households, which found that 7% of households were unbanked. To determine the check-cashing costs for unbanked households using prepaid debit cards without direct deposit and unbanked households using only cash, we assumed two paychecks cashed per month and a 1% fee of the check’s total value. We also assumed one money order sent per month with an average fee of $1.40.

For banking costs associated with using a NerdWallet-recommended checking account, we assumed two overdrafts per year costing $15 each and no other fees. For the average checking account, we assumed two overdrafts per year at a cost of $30 each as well as maintenance fees of $7.50 per month. To calculate average check cashing and money order fees, we used the FDIC’s data on the frequency of alternative financing services use by type of household (banked or unbanked), then applied the lower frequency of use among banked households to the average costs.

To calculate the average annual cost of prepaid debit cards, we looked at 69 cards, based on major issuers, high-traffic search volume, Pew Charitable Trust’s February 2014 report and the card offerings listed on Visa and MasterCard’s websites. For cards with multiple plan options, we counted each plan as a separate card.

The analysis includes the annual costs of a prepaid debit card with and without direct deposit for payroll. The median monthly fee used was $4.98, and the median out-of-network ATM fee used was $2.50. We used the maximum cash load fee of $4.95.