Many banks actively encourage their clients with low balances to overdraw their accounts. That means, if the customer writes a check or uses her debit card and has insufficient funds in the account, the bank clears the check by granting a temporary overdraft (a short-term loan), up to a specific limit. The customer is saved from the problems of bounced checks or interrupted shopping sprees.
Sounds like a good deal for the customers, right? That's what the banks say. They claim overdrafts are an added convenience to customers.
The truth is, they're often a very bad deal for the customers. Here's why.
When a bank grants a regular line of credit, the interest charged may be up to say, 20% or so. However, for overdrafts, banks don't charge interest -- they charge a flat fee on each transaction. This fee does not depend on the value of the transaction.
Let's see how that works. Overdraft plans fees may be as high as $35 per check. We'll assume a more conservative fee of $20 per check. If you have four checks totaling $200 that have insufficient funds against them and the bank automatically activates the overdraft and clears those checks, you will owe $80 in overdraft charges.
Unlike revolving lines of credit which you can repay at your convenience, an overdraft has to be settled in just a few days. Let's say the bank allows you to run the overdraft for 14 days.
A loan of $200 for 14 days incurring charges of $80 translates into an Annual Percentage Rate (APR) of 1043%!
A "convenience" for customers? Not at these rates.
What does this remind you of? It reminds me of payday loans and cash advances. Those are the other forms of lending which charge you such sky-high APRs. In fact, if you choose to repay a cash advance on due date and not roll it over, you'll likely be charged far less than what the banks charge you for an overdraft.
It gets even worse. Banks have software that ensures that your largest value checks and debits get processed first. There may be some logic to that. However, this arrangement also means that when there are insufficient funds in your account, instead of paying one overdraft charge on one large check, you pay several charges on several smaller checks!
Plus, most customers don't even realize that they are overdrawn until the bank notifies them about it.
Consumer advocates say that banks are perfectly aware that many people barely make it from payday to payday. These customers typically have very low balances. Rather than offer them a service that would be in their interests, banks extract high fees from them to cover bounced checks.
If you are caught short between paychecks, consider arranging funds from other sources rather than turn to overdraft protection. The best solution to the problem is to systematically build up cash balances so that you don't face such a situation in the first place.
Wednesday, September 2, 2009
Five Things To Check Out When You Apply For a Payday Loan
Are you thinking of going in for a payday loan to meet an unexpected expense? If so, look into these five things before you finalize one. This checklist can help you make smarter choices. You might even end up saving some serious cash!
First thing to consider -- do you really need that cash advance? Sure, you need cash right away, but have you looked at other options? The fact is, a payday loan is an extremely expensive source of funds, with Annual Percentage Rates (APRs) ranging from 300% to 1000%. So before you take one, see if you can arrange money by taking an advance from your employer or from your credit union.
You could also consider borrowing money from friends or family. Depending on your situation, credit card funding might be an option too, because it's usually cheaper than a payday loan.
Ask yourself how much you can really repay when the next payday rolls around. Work out an exact number you can commit to. Take a cash advance only for the amount you can repay, considering all charges as well. Obtain funds from other sources for any additional requirements you may have.
Here's why. If you choose to roll over all or part of the payday loan, you end up paying much more -- additional charges, late fees, etc. Your APRs start climbing rapidly and you may even find yourself trapped in a vicious cycle of payday loan debt. Stay clear of this trap.
Apply only for one payday loan at a time. Your application gets reported to a consumer tracking database used by payday lenders and banks. If you apply for multiple loans, the lenders may see the multiple applications and you might end up being rejected by all of them.
Go through the lender's approval criteria very carefully. Apply only to one where you can qualify. If you apply to a company that has stringent criteria and get rejected, that can actually hurt your chances of getting approved by another company with more relaxed criteria.
If you're applying online, ask yourself if the lender's website seems professional and well-organized. Do they have clear information and guidelines on the site? A comprehensive FAQ?
Most important -- do they have an SSL certificate on the application page? This indicates data is being transmitted securely. Secure pages have web addresses that begin with "https:" instead of "http:" and in addition, you'll see a lock symbol displayed in your browser. If a lender is using a non-secure page to collect information about you, find another lender!
Acting on the above points will help you make better choices about payday loans. The best solution is, of course, to get your personal finances into excellent shape so that you never need to borrow in an emergency.
First thing to consider -- do you really need that cash advance? Sure, you need cash right away, but have you looked at other options? The fact is, a payday loan is an extremely expensive source of funds, with Annual Percentage Rates (APRs) ranging from 300% to 1000%. So before you take one, see if you can arrange money by taking an advance from your employer or from your credit union.
You could also consider borrowing money from friends or family. Depending on your situation, credit card funding might be an option too, because it's usually cheaper than a payday loan.
Ask yourself how much you can really repay when the next payday rolls around. Work out an exact number you can commit to. Take a cash advance only for the amount you can repay, considering all charges as well. Obtain funds from other sources for any additional requirements you may have.
Here's why. If you choose to roll over all or part of the payday loan, you end up paying much more -- additional charges, late fees, etc. Your APRs start climbing rapidly and you may even find yourself trapped in a vicious cycle of payday loan debt. Stay clear of this trap.
Apply only for one payday loan at a time. Your application gets reported to a consumer tracking database used by payday lenders and banks. If you apply for multiple loans, the lenders may see the multiple applications and you might end up being rejected by all of them.
Go through the lender's approval criteria very carefully. Apply only to one where you can qualify. If you apply to a company that has stringent criteria and get rejected, that can actually hurt your chances of getting approved by another company with more relaxed criteria.
If you're applying online, ask yourself if the lender's website seems professional and well-organized. Do they have clear information and guidelines on the site? A comprehensive FAQ?
Most important -- do they have an SSL certificate on the application page? This indicates data is being transmitted securely. Secure pages have web addresses that begin with "https:" instead of "http:" and in addition, you'll see a lock symbol displayed in your browser. If a lender is using a non-secure page to collect information about you, find another lender!
Acting on the above points will help you make better choices about payday loans. The best solution is, of course, to get your personal finances into excellent shape so that you never need to borrow in an emergency.
Should You Ever Take a Payday Loan?
Payday loans have many names -- cash advances, signature loans and paycheck loans, etc. Payday lenders provide quick and easy short-term cash to those who need money immediately. That's the big reason why they're so popular.
However, payday loans come at exorbitant costs. This can -- and often does -- lead borrowers into a downward spiral of rapidly escalating debt. Let's look at the issue from various angles to get a complete picture.
First, the pluses. Here's why cash advances may hold enormous appeal for you.
You can have bad credit and still qualify for a payday loan. In most cases, no credit check is conducted.
The process is fast -- it takes as little as 20 minutes to complete. You can even find lenders who target approvals in 30 seconds!
There are no upfront costs -- so the buy-now-pay-later mentality can find full expression.
You can apply in person at a local outlet, over the phone or over the Internet.
You get funds deposited into your bank account in 24 hours.
Compared to some other sources for cash, payday loans are discreet -- no one else needs to know about it.
The transactions are secure -- your financial information remains private.
If you're faced with an emergency -- say, unexpected medical bills -- your only consideration might be to get money now. The speed and convenience of a cash advance comes in handy here.
So what are the disadvantages?
The most obvious one -- high costs. A payday loan can cost you say, $15 per two weeks. If you're borrowing only for two weeks, that doesn't sound like much. However, if you calculate the Annual Percentage Rate (APR), you'll see it comes to 391%!
If you don't think that's too much, let me ask you this question. If you invested money in the stock market, what would you consider a good annual rate of return? 20%? Maybe 30%? If you made a 20% return (on average) in stocks year after year, you'd be doing very well indeed. And this is for an investment that's generally considered high risk.
Now compare that with what the payday loan companies charge. You are providing them with a return on their money they likely won't get anywhere else on the planet!
There is another, less obvious reason why payday loans are dangerous. According to some estimates, over 60% of borrowers roll over a payday loan. Many take loans repeatedly, too.
Let's put in some numbers so that you can clearly see what rollovers imply.
Assume you borrow $400 for two weeks at a cost of $15 per $100 per two weeks. At the end of two weeks, you owe them a total of $460.
Let's say you don't repay the $400 at the end of two weeks. Instead, you request a rollover. So you pay them the lending fee of $60 and they agree to roll over the loan for another two weeks. The total cost of the loan at the end of 4 weeks may be as follows:
Original loan amount: $400Fresh lending fees payable: $60Late fees payable: $60 (assuming late fees apply at the same rate as lending fees)Lending fees already paid: $60Total: $580
At the end of this period (which is 4 weeks from the day you originally took the loan), you decide that you don't have $580 available and so request them to roll the loan over for another two weeks. Then this is what it can cost you in total at the end of 6 weeks:
Original loan amount: $400Fresh lending fees payable: $60Late fees payable: $60 Lending fees already paid: $120Late fees already paid: $60Total: $700
If you continue this process for six months (more specifically, for 24 weeks), this is what it may cost you in total:
Original loan amount: $400Fresh lending fees payable: $60Late fees payable: $60 Lending fees already paid: $660Late fees already paid: $600Total: $1780
For an original loan of $400, in a mere 6 months, the payday loan company will collect fees and charges of $1380 from you. That's 3.45 times the amount you borrowed. In APR terms that's 749.5%! If over 60% of borrowers roll over their loans, no wonder many payday loan companies are wildly profitable!
Snowballing costs can easily lead you into a debt trap if you get addicted to payday loans.
So what are the key points to keep in mind when dealing with payday loan companies? Two things:
First, avoid them if at all possible. The best way is, of course, to get your finances fully under control so that you always have cash and / or credit available to meet emergencies.
Second, if you do choose to borrow from payday loan companies, borrow only an amount you're 100% sure you can repay on the due date. If that amount is too low to meet your needs, get additional funding from other sources. Because rolling over cash advances is one of the worst things you can do to yourself.
However, payday loans come at exorbitant costs. This can -- and often does -- lead borrowers into a downward spiral of rapidly escalating debt. Let's look at the issue from various angles to get a complete picture.
First, the pluses. Here's why cash advances may hold enormous appeal for you.
You can have bad credit and still qualify for a payday loan. In most cases, no credit check is conducted.
The process is fast -- it takes as little as 20 minutes to complete. You can even find lenders who target approvals in 30 seconds!
There are no upfront costs -- so the buy-now-pay-later mentality can find full expression.
You can apply in person at a local outlet, over the phone or over the Internet.
You get funds deposited into your bank account in 24 hours.
Compared to some other sources for cash, payday loans are discreet -- no one else needs to know about it.
The transactions are secure -- your financial information remains private.
If you're faced with an emergency -- say, unexpected medical bills -- your only consideration might be to get money now. The speed and convenience of a cash advance comes in handy here.
So what are the disadvantages?
The most obvious one -- high costs. A payday loan can cost you say, $15 per two weeks. If you're borrowing only for two weeks, that doesn't sound like much. However, if you calculate the Annual Percentage Rate (APR), you'll see it comes to 391%!
If you don't think that's too much, let me ask you this question. If you invested money in the stock market, what would you consider a good annual rate of return? 20%? Maybe 30%? If you made a 20% return (on average) in stocks year after year, you'd be doing very well indeed. And this is for an investment that's generally considered high risk.
Now compare that with what the payday loan companies charge. You are providing them with a return on their money they likely won't get anywhere else on the planet!
There is another, less obvious reason why payday loans are dangerous. According to some estimates, over 60% of borrowers roll over a payday loan. Many take loans repeatedly, too.
Let's put in some numbers so that you can clearly see what rollovers imply.
Assume you borrow $400 for two weeks at a cost of $15 per $100 per two weeks. At the end of two weeks, you owe them a total of $460.
Let's say you don't repay the $400 at the end of two weeks. Instead, you request a rollover. So you pay them the lending fee of $60 and they agree to roll over the loan for another two weeks. The total cost of the loan at the end of 4 weeks may be as follows:
Original loan amount: $400Fresh lending fees payable: $60Late fees payable: $60 (assuming late fees apply at the same rate as lending fees)Lending fees already paid: $60Total: $580
At the end of this period (which is 4 weeks from the day you originally took the loan), you decide that you don't have $580 available and so request them to roll the loan over for another two weeks. Then this is what it can cost you in total at the end of 6 weeks:
Original loan amount: $400Fresh lending fees payable: $60Late fees payable: $60 Lending fees already paid: $120Late fees already paid: $60Total: $700
If you continue this process for six months (more specifically, for 24 weeks), this is what it may cost you in total:
Original loan amount: $400Fresh lending fees payable: $60Late fees payable: $60 Lending fees already paid: $660Late fees already paid: $600Total: $1780
For an original loan of $400, in a mere 6 months, the payday loan company will collect fees and charges of $1380 from you. That's 3.45 times the amount you borrowed. In APR terms that's 749.5%! If over 60% of borrowers roll over their loans, no wonder many payday loan companies are wildly profitable!
Snowballing costs can easily lead you into a debt trap if you get addicted to payday loans.
So what are the key points to keep in mind when dealing with payday loan companies? Two things:
First, avoid them if at all possible. The best way is, of course, to get your finances fully under control so that you always have cash and / or credit available to meet emergencies.
Second, if you do choose to borrow from payday loan companies, borrow only an amount you're 100% sure you can repay on the due date. If that amount is too low to meet your needs, get additional funding from other sources. Because rolling over cash advances is one of the worst things you can do to yourself.
Facts You Should Know About Types of Loans
When you set out to borrow, you often come across terms like unsecured loans, revolving loans, adjustable rate loans, etc. While these terms are more or less self-explanatory, it is still useful to be clear on their exact meanings and what they imply before you finalize a loan contract.
Unsecured versus secured loans
As the name implies, a secured loan is one where you offer some kind of collateral against the loan. The agreement is that if you default on the loan, the lender has the right (but not the obligation) to take possession of the asset you have pledged.
In most cases, this asset would be what the lender has financed. For example, when you take a home loan, you offer the home as collateral.
There may also be cases where you may need to offer additional collateral over and above the asset that is being financed. This happens, for example, when the lender is financing close to 100% of an asset that is prone to rapid reduction in market value. In such cases, the lender may insist on your putting up another asset so as to provide a reasonable margin of protection in case of default.
Unsecured loans are those where such collateral arrangements do not exist. These loans are granted based on your credit standing, ability to repay and other factors.
In cases where there's a choice available to the customer to take either a secured or an unsecured loan, the former may be offered at a somewhat lower rate. That is, assuming every other factor remains equal. This is because of the lower risk involved to the lender, who has recourse to a specific asset in case you default. However, this situation is comparatively rare in consumer financing, although it is more common in financing businesses.
Installment versus revolving loans
A revolving loan is one where you have access to a continuous source of credit, up to a pre-determined credit limit. If the limit is say, $10,000, you can borrow any amount up to $10,000. And typically, you can repay all or part of the amount you borrowed at a time of your choosing, within the overall tenor of the loan.
You pay interest only on the amount you borrow for the time you borrow it. Sometimes, banks may charge a commitment fee for making a revolving line of credit available to you. This fee is usually charged on the average unutilized amount of your limit.
You can also re-borrow the amount you have repaid. In effect, you have a loan that's always available to you on demand.
Unlike revolving loans, installment loans have a fixed repayment schedule. In most cases, the full amount of the loan is drawn down (i.e., borrowed) at once and both repayment schedule and amounts are fixed in advance. You do not have the option to re-borrow the amount that has been repaid.
Adjustable rate versus fixed rate loans
A fixed rate loan is one where the interest rate charged is fixed for the entire duration of the loan. The advantage is that you are immune to fluctuations in interest rates and can budget your cash outflows precisely. The disadvantage to you (the borrower) is that should interest rates fall, you lose in terms of opportunity costs. That is, you could have obtained a lower interest rate had you opted for an adjustable rate loan.
In practice, you can always choose to refinance the fixed rate loan at a lower rate if interest rates fall sharply enough to justify it. Bear in mind that your current lender may charge a pre-payment fee if you choose to repay before due date. So the difference in interest rates between your old fixed rate loan and the new loan should be large enough to justify a switch.
An adjustable rate loan is one where the interest charged fluctuates in line with a benchmark rate. This benchmark rate is usually the Prime Rate, which is what the US Treasury charges its prime (or best) borrowers. The advantage of an adjustable rate (or floating rate) loan is that what you are paying is more or less in line with the market. If interest rates decline, so do your costs and vice versa. The disadvantage is that your cash outflows for interest are unpredictable.
As a borrower, if you hold the view that interest rates are going to decline, it is best to opt for an adjustable rate loan. But arriving at the correct view consistently is easier said than done. Predicting interest rates is a game where even professional market participants and institutions frequently go wrong.
If it is important to you to be able to budget for your interest obligations in advance, a fixed rate loan may be the best choice. After all, you can refinance it should the interest rates fall significantly.
Keeping these basic facts in mind should help you make more informed borrowing decisions.
Unsecured versus secured loans
As the name implies, a secured loan is one where you offer some kind of collateral against the loan. The agreement is that if you default on the loan, the lender has the right (but not the obligation) to take possession of the asset you have pledged.
In most cases, this asset would be what the lender has financed. For example, when you take a home loan, you offer the home as collateral.
There may also be cases where you may need to offer additional collateral over and above the asset that is being financed. This happens, for example, when the lender is financing close to 100% of an asset that is prone to rapid reduction in market value. In such cases, the lender may insist on your putting up another asset so as to provide a reasonable margin of protection in case of default.
Unsecured loans are those where such collateral arrangements do not exist. These loans are granted based on your credit standing, ability to repay and other factors.
In cases where there's a choice available to the customer to take either a secured or an unsecured loan, the former may be offered at a somewhat lower rate. That is, assuming every other factor remains equal. This is because of the lower risk involved to the lender, who has recourse to a specific asset in case you default. However, this situation is comparatively rare in consumer financing, although it is more common in financing businesses.
Installment versus revolving loans
A revolving loan is one where you have access to a continuous source of credit, up to a pre-determined credit limit. If the limit is say, $10,000, you can borrow any amount up to $10,000. And typically, you can repay all or part of the amount you borrowed at a time of your choosing, within the overall tenor of the loan.
You pay interest only on the amount you borrow for the time you borrow it. Sometimes, banks may charge a commitment fee for making a revolving line of credit available to you. This fee is usually charged on the average unutilized amount of your limit.
You can also re-borrow the amount you have repaid. In effect, you have a loan that's always available to you on demand.
Unlike revolving loans, installment loans have a fixed repayment schedule. In most cases, the full amount of the loan is drawn down (i.e., borrowed) at once and both repayment schedule and amounts are fixed in advance. You do not have the option to re-borrow the amount that has been repaid.
Adjustable rate versus fixed rate loans
A fixed rate loan is one where the interest rate charged is fixed for the entire duration of the loan. The advantage is that you are immune to fluctuations in interest rates and can budget your cash outflows precisely. The disadvantage to you (the borrower) is that should interest rates fall, you lose in terms of opportunity costs. That is, you could have obtained a lower interest rate had you opted for an adjustable rate loan.
In practice, you can always choose to refinance the fixed rate loan at a lower rate if interest rates fall sharply enough to justify it. Bear in mind that your current lender may charge a pre-payment fee if you choose to repay before due date. So the difference in interest rates between your old fixed rate loan and the new loan should be large enough to justify a switch.
An adjustable rate loan is one where the interest charged fluctuates in line with a benchmark rate. This benchmark rate is usually the Prime Rate, which is what the US Treasury charges its prime (or best) borrowers. The advantage of an adjustable rate (or floating rate) loan is that what you are paying is more or less in line with the market. If interest rates decline, so do your costs and vice versa. The disadvantage is that your cash outflows for interest are unpredictable.
As a borrower, if you hold the view that interest rates are going to decline, it is best to opt for an adjustable rate loan. But arriving at the correct view consistently is easier said than done. Predicting interest rates is a game where even professional market participants and institutions frequently go wrong.
If it is important to you to be able to budget for your interest obligations in advance, a fixed rate loan may be the best choice. After all, you can refinance it should the interest rates fall significantly.
Keeping these basic facts in mind should help you make more informed borrowing decisions.
What You Should Know About Home Equity Loans
A home equity loan is essentially a type of second mortgage. You'll be borrowing money against the value of your home. This carries risk, but can be worth it in the end if you know what you're doing.
The most common type of home equity loan is a "closed end" home equity loan. This type of loan essentially allows you to borrow a certain amount of money against the value of your home. You cannot borrow more money on the same equity loan, so if you need more money later, you'll have to try and take out another loan.
Most people find that getting a home equity loan can go a long way toward helping them to get out of debt. Since you're borrowing money against your house, there is a greater chance that you'll end up with a lower interest rate than you're used to. This will probably result in a much lower monthly payment than most other loans.
One reason to get a home equity loan is if you are in a lot of debt and have several high interest payments to make each month. If you can get enough money in an equity loan to pay off your other debts, you'll be able to effectively consolidate all of your debt into one low monthly payment.
It is essential, however, that you make sure that you're able to meet your monthly payments after you get a home equity loan. After all, if you start missing payments, you might lose your house. Therefore, you should make a very careful assessment of your financial situation before you apply for the home equity loan. If you do not think that you'll be able to pay even the low monthly payments on this loan, then don't take the loan. If you're considering the laon for debt consolidation purposes, you might be better off looking at one of the many other debt consolidation options that are available to you.
The closed end home equity loan is not the only loan of its type. If you are looking for something that's a little more flexible, then you might want to go with a home equity line of credit instead.
A home equity line of credit works very similarly to a loan, and can definitely help you reduce your interest rates and monthly payments. The major difference, however, is that a line of credit will allow you to borrow more money against your house when needed - in some cases, up to 125% of your home's value.
While a home equity loan is better in most cases, the line of credit is a good idea if you're not sure how much money you need to borrow right away. With the line of credit, you can increase the amount of money you've borrowed against your house easily.
You will more than likely also want a home equity loan if you have a lot of credit card debt. While credit card interest rates are traditionally very high, home equity interest rates are fairly low. Since it's likely that you've ended up with several credit cards, you will probably have a lot of debt that you can easily consolidate with one home equity loan.
A home equity loan may be right for you if you need to consolidate debts quickly, and you're sure that you'll be able to pay off the home equity loan without missing any of your payments. If you are taking the loan for debt consolidation, be sure you have the discipline to use all of the loan for that exact purpose!
The most common type of home equity loan is a "closed end" home equity loan. This type of loan essentially allows you to borrow a certain amount of money against the value of your home. You cannot borrow more money on the same equity loan, so if you need more money later, you'll have to try and take out another loan.
Most people find that getting a home equity loan can go a long way toward helping them to get out of debt. Since you're borrowing money against your house, there is a greater chance that you'll end up with a lower interest rate than you're used to. This will probably result in a much lower monthly payment than most other loans.
One reason to get a home equity loan is if you are in a lot of debt and have several high interest payments to make each month. If you can get enough money in an equity loan to pay off your other debts, you'll be able to effectively consolidate all of your debt into one low monthly payment.
It is essential, however, that you make sure that you're able to meet your monthly payments after you get a home equity loan. After all, if you start missing payments, you might lose your house. Therefore, you should make a very careful assessment of your financial situation before you apply for the home equity loan. If you do not think that you'll be able to pay even the low monthly payments on this loan, then don't take the loan. If you're considering the laon for debt consolidation purposes, you might be better off looking at one of the many other debt consolidation options that are available to you.
The closed end home equity loan is not the only loan of its type. If you are looking for something that's a little more flexible, then you might want to go with a home equity line of credit instead.
A home equity line of credit works very similarly to a loan, and can definitely help you reduce your interest rates and monthly payments. The major difference, however, is that a line of credit will allow you to borrow more money against your house when needed - in some cases, up to 125% of your home's value.
While a home equity loan is better in most cases, the line of credit is a good idea if you're not sure how much money you need to borrow right away. With the line of credit, you can increase the amount of money you've borrowed against your house easily.
You will more than likely also want a home equity loan if you have a lot of credit card debt. While credit card interest rates are traditionally very high, home equity interest rates are fairly low. Since it's likely that you've ended up with several credit cards, you will probably have a lot of debt that you can easily consolidate with one home equity loan.
A home equity loan may be right for you if you need to consolidate debts quickly, and you're sure that you'll be able to pay off the home equity loan without missing any of your payments. If you are taking the loan for debt consolidation, be sure you have the discipline to use all of the loan for that exact purpose!
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