It can happen, you know...
One day, you become enthralled with a new idea for a coffee machine. Maybe because you get throbbing headaches if you miss your morning coffee, and would rather make a spoonful of instant coffee than endure the Starbucks queue for their Zombie Frappuccino.
And now you think it's time to invest in a proper coffee machine. Nothing beats the idea of brewing a cup of coffee in the comfort of your home, you convince yourself - thanks to the ever-innovative kitchen tech.
So you check around and find this fine coffee maker, your face is beaming, your taste buds are rioting. You want this coffee maker now.
But, there’s a problem. It’s that time of the month you’re bootstrapping. You can’t afford it.
Worse?
The coffee machine is selling at a discount. You may never find this opportunity.
Your world explodes in an inferno of thoughts. You want it so badly yet you don’t have the money.
Your creative juices start flowing. You start looking for ways to get money quickly, even though you know your credit history is nothing to write home about.
Of course, that’ll never happen to you, right? Well, you might be surprised.
When you need quick cash, and you have bad credit, it’s tempting to take whatever credit terms you can get. Your options are limited, and payday loans or title loans may seem like a solution to your problems.
But some rookie mistakes can make your financial situation worse and make you look like a world-class idiot.
Let’s look at some of them and make sure you never fall into these financial traps.
1. Rushing to take a payday loan
Payday loans are short-term loans where the lender extends a high-interest credit to you based on your income and credit profile. They are also called advance loans or check advance loans. The loan is typically between $100 - $1500 to be repaid within two weeks in a lump sum on your next payday.
They target people with poor, no credit, or little financial literacy- but need cash immediately.
You’ll love payday loans because of:
Easy access usually within 24 hours
Fewer loan requirements
No credit history checks
It’s also unsecured. No need to surrender your log book or property.
But the convenience comes with disadvantages you should never ignore.
A. They’re damn expensive - Depending on the state, payday loans have extremely high-interest rates of about 400% if you compare with other personal loans. Most personal loans charge about 4%-36% pa interest while credit cards charge between 12%-30% pa.
How much do you pay back on a payday loan?
Most payday loan lenders charge a fee of $15 per $100, which is equivalent to almost 400% for a two weeks loan.
For example, you need to borrow $300 before your next payday in two weeks; it would cost you $345 to pay it back, assuming the rate is $15 per $100.
B. They’re predatory - They’re unfair and misleading. Their un-affordable terms can potentially trap you in a cycle of debt. Some lenders don’t check whether you can repay the loan forcing you to roll over repeatedly, accumulating new fees every time.
Suppose you’re unable to pay when the loan falls due and your state law permits rollovers, your lender may allow you to pay only the fees due and extends the due date. They will then charge you another fee and still owe the entire original balance.
Using our $300 loan example, if your renewal rollover fee is $45, then you’ll still owe $390. That’s just $90 in 4 weeks. If it takes you three months to repay your loan, you will have paid
$270 in interest. That's almost as much as the original loan. Oh yeah, you still owe that too.
That’s ridiculous, but let’s look at another trap.
2. Rent to own furniture
Rent to own furniture is where you rent a major household appliance or piece of furniture. It isn’t a loan, so your credit score doesn’t matter, but it’s an expensive way to buy new items.
Rent to own stores give you two options. You either buy your item through a regular weekly payment or lease it to return at the end of the rental period. Both options allow you to return the item when you no longer want to make payments.
Rent to own furniture is attractive because it seems more affordable in full over the term of the rental- you own the item.
But the rental period is much longer, and after calculation the total expense, you end up paying far more than a conventional loan would have demanded.
Why is rent to own furniture so expensive?
Weekly payments might look low, but they add up too quickly and often cause you to pay much more than something is worth.
The seller might also charge you additional fees that aren’t factored into the total price of the item. Such costs include the cost of delivery, installation and repair fees, late payment fees. They may also repossess the item in case you default and charge you a collection fee.
Let’s look at an example:
Say your refrigerator is faulty, and you don’t have money to buy a new one. Your local rent-to-own store has a decent refrigerator on sale and offers to deliver quickly. You don’t need to make a deposit, and they don’t need your credit score for approval.
Deal. Right?
The seller gives you a weekly payment plan of $27 per week, but he also says the cost of the refrigerator will cost you around $925 if you pay it within 90 days. However, the way your seller set up the $27 weekly payments is a rip-off. You’ll end up paying about $2083
(19 months/77 weeks) that is $1157 above the ticket price of the refrigerator.
See how that’s a rip off? Let’s look at the third trap.
3. Title loans
When you need cash quickly, and you own a car, a title loan becomes your quick answer.
A title loan is small loan amounts payable within one month (30 days). In exchange for the loan, you give your lender your car title until you repay the loan in full. They are appealing because of their fast processing and no credit checks. But you should think twice before asking for one. Their interest rates are high, just like the payday loans.
How do title loans work?
To qualify for a title loan, you need to have equity in your car. Many lenders will require that your car is free and clear- meaning you don’t have other outstanding loans on the car.
Once the lender approves your loan, they take the title to your car. Even though you can continue driving your car, some lenders may install a GPS device to track it even make a copy of your keys. They use these tactics to help them repossess your car if you default on the loan. You can borrow between 25%-50% of the value of your car, with some lenders allowing $10,000 or more. The loan term is usually 30 days to even a year.
Why title loans are expensive
The annual percentage rate (APR) can be around 300% i.e., 25% in interest per month.
Let’s say you borrow $1000 with a monthly interest (monthly fee) of 25%. You’ll need to repay $1250 within 30 days, excluding any additional costs you may have to pay.
Just like payday loans, they can also lead you in a cycle of debt. If for any reason you’re unable to repay the loan on time, your lender may offer to renew or rollover your loan into a new loan. The new loan attracts additional fees on the amount you already owe. You’ll end up paying $500 more in fees just in 60 days. With cost piling up every month, you could face bigger challenges if you can’t afford to pay the loan in full. Repossession!!
But, there are better and cheaper options. And that’s what you’ll learn next.
Best option: Save money from your salary
So, how much should you save every month? That’s a great and important question to ask if you are hoping to avoid debts and stretch your paycheck as far as possible. The amount to save comes down to how much you want to take home, your expenses, and if you‘re repaying any debts.
However, the 50/30/20 rule is an excellent place to start. 50% goes toward your essential monthly expenses, 30% towards spending, and 20% towards your savings.
Let’s assume this is your average salary is $100,000 per year.
Your biweekly paycheck amount is $3846
50% allocation to essential services: $1923
30% allocation to discretionary spending $1153
20 % allocation to savings $769
Using the numbers above, you should be putting $769 away into your savings every two weeks. Over one year, that adds up to $20,000 if you’re basing your bi-weekly savings after your retirement contributions are taken out.
Let’s go back to our refrigerator example that would cost $925 if you paid within 90 days. You can actually afford to pay it in cash within 6 months or even earlier if you choose to reduce your discretionary spending to save more.
Will you consider saving money from your paycheck?
Establish regular savings habits. But always remember to have a savings goal. Having a clear goal or purpose in mind for the money you save will help motivate you to stay on course.
Avoid payday loans, title loans, and rent-to-own kind of deals. They are quick and easily accessible, but the result is detrimental. All they do is prey on your poor credit history and limited credit options.
Maybe you don’t even need such expensive items. But you get the idea; it’s possible to save for something. You only need to get started and nurture the discipline.
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