Monthly Archives: December 2010

Payday Loans + APR = Very Bad Idea

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The following guest post is from Jeff Rose. Jeff is a Certified Financial Planner in Illinois, authors the blog Good Financial Cents and is currently working on his first book Soldier of Finance.

I’m not shy about talking about payday loans. In other entries to my blog, you’ve heard me condemn them up and down, backwards and forwards. (Trust me. I’m not done yet.) I’ve even put them near the top of my list of financial Weapons of Mass Destruction. I can’t say enough about how destructive this kind of lending is. They don’t call it predatory lending for nothing, that’s for sure.

I’ve laid out before a number of reasons why payday loans are a flat out bad idea, so I thought I’d use this entry to go into deeper detail about maybe the most important part of what makes payday loans such a rip off.

The APR. Trust me, it’s absolutely, positively, astronomical.

The Basics of APR

I don’t want to assume everyone knows what I mean by APR, so let me frame it up for you quickly before I get too deep into why payday loan APRs are so horrible. Stick with me for a minute, and I promise – you’ll be able to see for yourself why payday loan APRs are not to be messed with.

APR stands for annual percentage rate. In summary, this is the rate at which your loan accrues interest. In plainer English, this is the amount of money you have to pay beyond what you were loaned. To the person who loaned you the money, this is the profit.

Simply having an APR isn’t bad. Most forms of credit and most loans are made profitable through an APR. It’s a necessary part of the credit industry.

What makes payday loan APRs so ridiculous is how high they are. Percentage rates on these are many many times higher than most other forms of credit reinforcing why you need to avoid payday loans at all costs.

Typical Loan APRs

As I mentioned, most forms of credit have an APR. The difference between traditional forms of credit (like mortgages, credit cards, student loans, etc.) and payday loans is that most traditional forms of credit have at least a somewhat reasonable APR, and a payday loan has an exorbitant APR.

For example, a typical credit card’s APR is somewhere between 7% and 36%. Now, I know that’s a big range, but it goes to show you where someone who doesn’t have good credit would be placed – out at the upper end of the 30% range. Please don’t get me wrong – that’s not, by any stretch of the imagination, a good rate. If you have credit cards at that rate, it might make sense to talk to someone about consolidating your debt. Our current Visa carries a rate of 9.99%, but also remember that we pay it off each month.

For a second example, a car loan APR is usually somewhere between 5% and 15%. 15% is certainly on the very high end, but again – I bring it up because it’s an excellent example of typical APRs, and will help to show you just how ludicrous payday loan APRs are.

As a third example (and then, I promise, I’ll show you some actual examples of payday loan APRs), let’s consider mortgage rate prices from January 2010 through to the end of October 2010. Over that period of 10 months, mortgage rates ranged from 5.21% to 4.19%. Keep that in mind as we move on.

It’s worth mentioned that car and mortgage loans are usually for large sums of money, so lenders can afford to charge a lower rate. They still make plenty of money. 4.19% of $200,000 is $8,380, and that’s before you take compounding into account. Not too bad for a few days work.

Some Actual Payday Loan APRs

How does 521% sound? That was the stated APR for a lady that I met with that was struggling with her debt. The was the highest rate she had, with the others all being above 300%. If you ask me, it sounds absolutely ridiculous. And that’s not even the highest it goes. Payday loan APRs can range from about 390% to 780%.

Did your jaw hit the floor yet? Well pick it up and make this promise to me and to yourself right now.

“I promise to NEVER get a payday loan. I promise to remember that there are other options, and to explore what they are before making drastic decisions about my finances.”

Trust me, they simply aren’t worth it.

To Pay Off Debt or Save? That is the Question

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In uncertain financial times like these, we all tend to focus more sharply on money matters. This is actually good news, because this new focus can help us educate ourselves and develop healthier financial habits for the future. One question that comes up frequently in analyzing personal finances is, should I pay off debt or save money?

We hear a lot about how Americans don’t save enough for the future, and how important it is to have an emergency fund for a rainy day. But we also hear a lot about the importance of getting out from under crushing credit card debt. So it’s only natural to wonder which is more important.

At first glance, you might think the answer is always “pay off debt first.” But there are a few things that you should consider before taking this advice.

1. Know Thy Enemy. Sometimes consumers do the wrong thing, for the right reasons. For example, given all the hair-raising news about eroding home equity and foreclosures, many consumers are pumping extra cash into paying off their home mortgage, rather than directing that money towards other more potentially dangerous debt like credit cards.

It is unwise to pay down your relatively low-interest, tax-deductible home mortgage, student loans, or business loans if you carry other more volatile forms of debt.

2. Break the Piggy Bank. As painful as it sounds, many times cashing in your low-interest savings account to pay off a high-interest credit card is the right choice.

Interest accruing in most savings accounts can’t keep pace with the interest accruing on a credit card account, so it is generally a wise move to raid the savings account to help get out of debt.

3. Divide and Conquer. When analyzing debt, carefully consider what motivates you the most towards repayment. Does paying interest drive you nuts? Perhaps paying off your highest interest rate card first make sense. Do you need some quick wins? Maybe you should pay off a couple low-balance cards early in your plan. However you decide to do it, figure out a way to single out one debt and make it your top priority.

Pay the minimums on your other cards until you slay the beast with the highest interest level, the highest emotional involvement (a personal loan to in-laws, for example), or the lowest balance (following the debt snowball method). Then move to the next worst offending debt and so on.

4. Know Thyself. There are two schools of thought regarding saving vs. paying off debt. One school of thought is that you should pay off the debt entirely before beginning a savings regimen. This works well until the bottom of your hot water heater gives way unexpectedly and you wind up with a hefty cleanup charge, which might lead to a credit card tailspin.

If you are the type of person who can stick with a payment plan, regardless of occasional setbacks, you should pay of your credit card debt first. If you are more likely to be derailed and disheartened by an unexpected expense, it might be wiser to focus on creating a rainy day fun, while committing to a cash-only plan for new purchases.

Once a small nest egg is built, then the attack on debt can be renewed with more confidence.

5. Hands off the Cookie Jar. In the rush to get out of debt, some people consider tapping into or liquidating their 401(k) or IRA funds. This is a poor personal finance move, since not only will you be gouged by Uncle Sam upon withdrawing the funds prematurely, you will also be losing the long-term impact of those funds on your overall financial well-being.

Some folks might stop short of cashing in their retirement funds, but instead decide to take a loan out against their 401(k). This can be a viable option for a disciplined borrower, but beware that failure to payback the loan from your 401(k) in a timely manner can result in weighty tax consequences and stiff penalties. Also keep in mind if you are laid off, or you decide to switch jobs, the loan may be due in full immediately.

For those tackling debt, how have you decided to go about it? Save first, pay off debt, or a little of both?

Weekly Roundup – Extra Income Guide Edition

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This time of year, a lot of people are looking for ways to make a little extra money. The site Moolanomy recently shared an incredible extra income guide, which breaks down the various types of income, how to earn it, etc.

After many unsuccessful, or at least less-lucrative, attempts at side hustles, I’m glad I finally settled on blogging. It was slow going the first year or so, but the great thing about blogging is it is sort of a passive/active hybrid business.

Posts that I wrote months, or even years, ago still bring traffic to the site for which I make a small bit of advertising revenue. Of course, you still have to feed that stream with a steady dose of new content, but once things get going, it is much easier to maintain.

I’d love to hear from others out there hustling for a side income? What are you up to?

The Frugal Roundup

  • Frugal Trader shares how they paid off their mortgage in three years. How exciting to know we could be mortgage-debt free three years from today by using a similar strategy.
  • Ron put together 9 ways to improve your home for less than $100. We’re gearing up to do a little painting ourselves. I actually like to paint, it’s the prep and clean-up I hate.
  • I like Trent’s idea of creating a five year sketch, rather than a five year plan, which doesn’t sound nearly as fun! My end result will be part sketch, part detailed plan, part pie-in-the-sky dream.
  • Steve wonders if working for a salary is a bad deal. My problem with working for a salary is efforts are rarely rewarded quickly enough. If you bust your butt on a project in March, you may not see a boost in salary until the next January. On the other hand, if you close on a big sale and get a commission, or land a new client and see new revenue to your own bottom line, instant reward.
  • Along those same lines, this piece asks the all-important question regarding income – do you want a predictable income, or are you willing to take some risk? I’d like a little of both.

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10 States to Relocate for Lower Taxes

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When you think of retirement, you might think of puttering around the house, catching up on projects, and spending time with family and friends. But a wiser plan might be to ditch the homestead and the neighborhood pals and strike out for greener pastures. Where you live can dramatically affect how much of your retirement money stays in your pocket. Relocating to an area with lower taxes can help you stretch your retirement funds considerably.

Morning Street, Charleston, SC by faungg on Flickr

There may be no escaping federal income taxes, but state income taxes can sneak up and take a significant bite out your wallet. Your first thought may be to head for a well-known retirement destination with no state income tax such as Florida or Texas, but there are many issues to weigh before making a move, such as:

  • State and local sales tax
  • Property tax
  • Estate and inheritance taxes
  • Housing costs
  • Insurance premiums
  • Relocation and annual travel costs
  • Quality of life factors (recreation, security, lifestyle)

A major consideration is the state’s laws governing taxes on different types of retirement income. Different states have different rules governing taxes on Social Security income, government, military or private pensions, and disbursements from retirement accounts such as IRAs and 401(k)s. Review state tax laws that apply to your particular retirement portfolio when considering relocation.

To help in the hunt for ideal places to relocate, here is a list of 10 retiree-friendly states:

1. Alaska. While this polar state might not be everyone’s idea of a retirement paradise, there is a certain undeniable appeal to the fact that the state has no state income tax and no state sales tax. In addition, all residents (after the first year) receive a hefty annual dividend check from the state’s oil coffers. Many older residents are exempted from property taxes on the first $150,000 of assessed value.

2. Alabama. With a mild southern climate, and attractive real estate prices, Alabama is an overlooked retirement spot. Homeowners over 65 are exempt from state property taxes and the state has a lower-than-average state sales tax of 4%. There are no taxes on pensions or Social Security.

3. South Carolina. South Carolina is another state popular with snowbirds fleeing colder climes and seeking lower taxes. There is no Social Security tax and couples can deduct the first $30,000 of retirement income from their state taxes. Up to $10,000 in military benefits can also be deducted. State sales tax is 6% but prescription drugs are exempted. The sales tax falls to 4% at age 85. Property taxes are low and older taxpayers qualify for a homestead exemption that further reduces their tax liability.

4. Mississippi. Property taxes are some of the lowest in the U.S. and there are no pension or Social Security taxes. Distributions from IRAs, 401(k)s and other qualified retirement accounts are also excluded.

5. Nevada. Nevada has no state income tax and food and prescription drugs are exempted from the 6.85% state sales tax.

6. Pennsylvania. Social Security and pension income are exempt in PA. The Keystone state also keeps its paws off retirement accounts such as IRAs and 401(k)s. Be aware that property taxes vary widely from place to place.

7. South Dakota. There is no tax on Social Security benefits or on any other pension income. The state sales tax is a below-average 4%, and prescription drugs are exempt. Homestead exemptions and other tax reductions are available to seniors.

8. Tennessee. While there is no tax on Social Security or other pension income, dividends and interest are subject to tax. The state sales tax, at 7%, is on the high side.

9. Wyoming. Pensions and Social Security income get a free ride in this income-tax-free state. Sales tax is a low 4%, and prescriptions and food are untaxed. These facts, plus low property tax rates give Wyoming residents one of the lowest overall tax burdens in the country, putting this state high on the list of retiree-friendly places to relocate.

10. Delaware. This tiny state has no state sales tax, and state income taxes are on the low side with exemptions for Social Security and other qualified income for taxpayers over 60. A credit toward property tax is also available for homeowners over 65.