The Cost of Overdraft Fees & How to Avoid Them
Need Money Now? Your Eight Options
If your month is lasting longer than your income, then you have eight options to get yourself out of your jam:
Your Emergency Fund
This is the smartest way to handle unexpected expenses. An easy way to create an emergency fund is to open a savings account at your bank or credit union. If you have direct-deposit, direct your payroll department to split your paycheck so that most of your pay goes into your checking account as usual, and $20 or $30 is diverted into your savings account. That way you never see the $20 or $30, and after a year or two you have a nice sum set aside for an unexpected car repair, medical bill, or other unbudgeted expense.
With discipline over time, you can divert more into this account. When the account grows large enough, you can move some of this money into long-term investments, such as a no-load mutual fund.
This is perhaps the most common form of loan people use when they do not have enough in their bank account to pay for an unexpected expense. The interest expense varies, but rarely exceeds 18%. Some credit card issuers encourage cardholders to use their credit cards for everyday purchases to earn points that can be converted into free airline tickets, other services, and cash. The risk in over-using a credit card is allowing the balance to creep upwards each month to the account’s credit limit, which will damage your credit score.
If you can see you are about to dip under zero on your account balance, it's a one-time event, and your account has overdraft protection, then consider this option. Overdraft programs are really short-term loans in disguise. Beware to not to rely on overdrafts often because of the expense. The average overdraft fee for a bank is $35 and $27 for a credit union. Plus banks add a daily fee of about $12 for every day you are overdrawn, making overdrafts a very expensive money source.
Overdraft plans for ATM cards are optional, and have been since 2010.
An unsecured loan is another possibility. Talk to your bank or credit union about opening a line of credit, or if you qualify for a signature loan. Another possibility is a peer-to-peer loan from Prosper or Lending Club. The cost of these unsecured loans varies with your level of creditworthiness. High-risk borrowers pay higher rates than the well-healed.
Payday loans are another form of unsecured loan. There are two distinctions between a payday loan and a loan from a bank or P2P lender. The first is if you have a job you qualify for a payday loan. The second is you give the payday lender permission to access your checking account. When you are paid, the payday lender makes an automatic withdrawal from your checking account. Payday loans are not legal in all states, and many Bills.com readers report problems with Internet lenders withdrawing more from their checking accounts than the lenders promised they would.
The interest rate and fees on payday loans are very high, which makes this an expensive option. If you have no option but a payday loan, go to a local storefront for your loan and avoid online lenders. Local storefront lenders are subject to your state’s consumer protection laws, which may not be the case for Internet lenders.
Tap a Friend or Relative
Borrowing from a friend or relative is a a good option because the terms will likely be reasonable. The huge risk here is if you can’t repay the loan, you risk losing the trust and friendship of someone important to you.
Title loans are often offered by payday lenders. A title loan is where you surrender your vehicle’s title to a lender in exchange for a loan. Interest rates vary but tend to by high. The risk is if you fail to make a payment the title lender has the right to repossess the vehicle. Title loans should be considered as a last resort due to their tremendous risk.
Sell An Asset
Do you really need everything in your garage or closet? Take a close look at what you own, and free-up space and put cash in your pocket by selling your unneeded and unnecessary items on Craigslist.
If you’re a homeowner, you also have the option of a cash-out refinance. Due to the recession and crash in housing prices from 2009 through 2012, a cash-out refinance was not a viable option for many homeowners. With the recovery in housing prices starting in the spring on 2013, a cash-out refinance might be worth exploring if you have significant equity in your home.
Risks of Short-term Solutions
Make sure you understand the risks shared by each of the six loan options just mentioned. They include:
All short-term loans come at a high cost. Payday loans are infamous for their 500% APRs, but these rates pale in comparison to the effective APRs for overdraft fees, which are in the thousands. Lenders can charge these rates because of the laws of supply and demand and federal bank deregulation rules that all but wiped out state usury laws for nationally chartered banks and payday lenders.
The CFPB is seeking to clarify bank overdraft disclosures, and has indicated it may do the same for payday lenders. Until that happens, read the fine print in any loan you consider. You may be in for an unfortunate surprise. For example, some Internet loans are administered through businesses based on American Indian land. Because this land is sovereign entities, these loans may not be subject to your state’s lending laws. If you have a problem with the loan, your state’s attorney general or banking authority may not have the ability to assist you.
Trapping Yourself in a Debt Cycle
Because of their high cost, short-term loans can cause you to get trapped into a cycle of opening new loans to repay the interest and fees on earlier loans. Be sure you know how you will repay a loan before you sign on the dotted line.
A Different Approach
Step back and look at your present financial situation as a whole. Are you overspending your income on a routine basis? Are your credit card payments overwhelming you? Do you have a large, unexpected medical debt you cannot repay?
Start by reviewing your household budget. If you do not have a budget, start with this budget and learn if your monthly income is more than your monthly expenses. If your expenses are more than your income, you need to cut your expenses or, if possible, find a way to increase your income.
Look at how much you are spending on your existing debts, such as credit card payments. If your debt payments are more than a third of your income, then consider your debt relief options.
- Develop a household budget and stick to it
- Bank at a local bank or credit union that charges lower overdraft fees than the national banks
- Opt-out of debit card overdraft programs offered by your bank or credit union
- Consider a loan if you can foresee a temporary cash-flow shortfall
- Consider a debt relief option if your debt payments are overwhelming you