You’re two weeks away from payday, and your car breaks down. The fix is going to cost $100. The problem is, you don’t have enough money in the bank for food, much less a $100 car repair. You need your car. You have places to go. Your kids have places to go. You need to get them there. So you do an internet search for “low cost” payday loans. You find a place that will only charge you $10 to borrow $100 for two weeks. Perfect! The loan will only cost you $10, right?
Maybe. Maybe not.
Payday loan companies advertise low costs and fees. After all a $10 fee on $100 is only 10%, right? Well, yes, but the question you should be asking is “What is the APR?” The answer is eye opening.
To figure out the APR, or annual percentage rate, you just need to do a little math. Don’t worry. It’s not calculus.
First, you need to turn your $10 fee into a yearly amount. The fee is for a two week period. There are 52 weeks in a year. Divide 52 by 2 to get 26 two week periods. Then multiply 26 by $10, and you get a fee of $260 a year. That’s the first step.
Now to find the APR, take your annual charge and divide it by the amount of your loan. Multiply that number by 100 to get the percentage rate, and you have the APR. In our example, we take our annual charge of $260 and divide it by $100 (our loan amount) to get 2.6. We multiply that by 100 to get an APR of 260! Yes, an APR of 260 is low cost when it comes to payday loans, but in the grand scheme of life, it’s highway robbery!
Even though I hate credit cards, it would be much better to take a cash advance from a credit card at 20% APR than to get a payday loan at 260% APR! Just make sure you pay it back ASAP.
We’ve talked numbers. Now let’s talk about life. If you’re two weeks away from payday, and you don’t have $100 to pay for a car repair, what makes you think you can afford $100 when your next payday rolls around?
If you have no emergency fund to handle expenses such as these, it means you’re spending every penny you make, every pay period. That’s a problem bigger than payday loans.
I realize that in this economy there are many people who are unemployed and underemployed. I believe you when you say your paycheck barely covers life’s necessities. I’ve been there.
However, if you take out a loan you can’t afford, it will catch up with you. Many borrowers of “low cost” payday loans find out the price is too high. Payday rolls around, but your paycheck is barely enough to cover the bills. The payday loan company rolls your loan for another pay period, adding on another $10 fee. The next payday rolls around, and now you owe $120, but you can’t afford it, so the loan is rolled again, making it $130. You’re stuck in a never-ending cycle.
It’s stressful. Financially, it’s unsustainable. There has to be a better way.
Now that we’ve determined the true high price of so-called low cost payday loans, how about some alternatives? As much as someone living paycheck to paycheck might want to save an emergency fund, it won’t happen overnight. And there’s bound to be an emergency just when you can least afford it. So what can you do?
Sell something. It’s free to list something on Craigslist, so sell something. Furniture, clothing, electronics, anything. Sure, it’s painful, but it’s less painful than being caught in a cycle of debt you can’t repay.
Look for alternatives. In the case of our example, she could take public transportation, walk, or ride a bike to work. And I’m all for kids being involved in activities, but I’d rather give up the activities for a couple of weeks than go deeper into debt. But chances are someone on the soccer team will offer to pick up your son, if you make your needs known. So ask around.
Work. If you’re on an hourly wage, ask if you can pick up a few extra hours. If that’s not a possibility, offer your services as a babysitter, housepainter, dog walker, or anything else you can think of. Place an ad on Craigslist advertising your services.
For even more ways to make some extra money, check out PT Money’s ebook, 52 Ways to Make Extra Money.
Then plan ahead. To make sure you are never again in a position to even consider taking a payday loan, make a budget and build an emergency fund. Work on finding a steady stream of extra income, and slowly work your way out of living paycheck to paycheck.
Have you ever taken out a payday loan? How did it work out? Would you do it again?
Photo by kevindooley.
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I'm just an average mom, trying to live a frugal life and get out of debt. I write about things that have (and haven't) worked to improve my family's financial situation. What works for me may or may not work for you, and you should always consult a financial advisor before making important financial decisions.
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