FAST CASH CAN EQUAL COSTLY DEBT
By Carolyn M. Brown
Need money in a hurry? Why not get a payday loan, right? Wrong. These highly advertised, quick and convenient loans can end up being very costly cash indeed. The average payday loan is usually for around $200 and lasts 14 days to 17 days, with fees ranging from $15 to $30 for every $100 borrowed.
Payday loans are another form of predatory lending. Some consumer advocates even call it "legal loan-sharking." Payday lenders charge anywhere from 10 to 20% in interest every two weeks, not per year as with credit cards. With such a short duration for such loans, fees add up to roughly a 400% annual percentage rate.
In essence, payday loan companies work a little like check-cashing stores. But instead of cashing a check you have in hand, they loan you money you don't have against your future pay. The only requirement is usually a pay stub, or a telephone call to an employer to verify that you have a job. You also have to have a personal checking account.
The fast cash method works like this: Sonia's bills are pilling up but she won't get paid for another two weeks. A quick $300 would see her through. She heard an announcement over the radio about a payday loan. All she has to do is write a post-dated check for $380 to borrow $300. The payday lender agrees to hold her post-dated check until her next payday. What if Sonia doesn't have the money in two weeks? She can roll it over for another 14 days at the cost of an additional $90, which is automatically taken out of her bank account. Soon, she is caught in a revolving door of debt by continuously rolling over the loan. A year later, she could end up paying $1,800 in interest on top of the original $300.
This scenario is all too real, especially for individuals caught in the cycle of living from paycheck to paycheck with the aid of credit cards. But the sad truth of the matter is that many people aren't even using the loans for emergencies (e.g., medical bill or car repairs). Consumer groups estimate that six out of ten borrowers are using payday loans for discretionary spending. You know, items that could easily be put off for another 30 to 60 days, such as purchasing a new DVD player, XBox360 or designer purse.
Chances are if you have solid credit, substantial savings, or other means of borrowing money, you've never considered a payday loan. But many, many others have. According to industry trade groups, more than 7,000 payday advance locations in the US have made $65 million in payday loans and taken in $2.4 billion in fees. That figure is expected to double in the next few years.
At first glance it may make sense that if payday lenders meet the need of households experiencing cash-flow shortfalls between paydays by providing loans in amounts under $500, then they should have a right to charge interest on such loans. Some industry reps argue that a bounced check cost more because financial institutions charge a penalty of $20 to $30. The place where the check was bounced is also likely to charge a penalty.
The problem with payday loans, however, arises when borrowers roll over the loan several times. Studies reveal that 75% of payday borrowers roll over their loans at least once. A Georgetown University study reports that 33% of payday borrowers roll over their loans seven or more times. Payday lenders are banking that borrowers will not be able to pay their loans at the end of the two weeks and will then be assessed another fee, multiplying the already high interest on the original loan.
Before there were payday lenders, financial advisors note that people dealt with debt issues by negotiating repayment plans with their creditors (or using a consumer credit counseling service to do so on their behalf), using over-draft protection on their checking account, or going to a legitimate finance company.
If you are seriously strapped for cash, the following suggestions are better alternatives to getting a payday loan:
GO TO A CREDIT UNION
Consider a loan from your credit union or an advance on your paycheck from your employer. Many credit unions nationwide are working with their customers to get them to establish emergency savings accounts through payroll deduction or direct deposit. A cash advance on your credit card is an option, but it will cost you in terms of a higher interest rate.
TRY LOCAL CRISIS INTERVENTION PROGRAMS
Check with local community-based organizations that may grant small or micro loans to individuals. Many city social services departments have programs to provide emergency financial assistance to low- and moderate-income families. Also, many faith-based groups provide emergency cash either directly or through social services programs. The very church you attend may even be a source of funds.
ASK FOR A LITTLE HELP FROM FAMILY OR FRIENDS
If a relative tells you the money is a gift, then no sweat. But if it is a loan, make sure you create a written agreement indicating what the money is for and when you intend to pay it back.
BORROW MONEY FROM YOUR 401(k), OR WITHDRAW FROM AN IRA
Choose wisely if you do have to take money from your retirement funds. Take advantage of the loan provision in your 401(k). At least you are paying back the money - and the interest on the loan - to yourself. You can also take money out of an IRA to cover medical expenses, tuition and related educational expenses, or a down payment on a first home. You won't pay the 10% penalty for early withdrawals before age 59 1/2, under such circumstances.
Standard wisdom says that you should have enough cash stashed away to cover at least three to six months' worth of living expenses - rent, food, and utilities - in case of an emergency. Yet, the sad truth is that 44% of US households don't have any type of savings at all.
Saving three to six months' worth of living expenses may seem daunting if your income is moderate and you have a lot of debt. So start by aiming for an easier alternative, such as one month's worth. Seek ways to reduce unnecessary spending (such as cutting down on eating out and visiting the nail salon) to add more money to your cash reserve.
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