I was pretty upset when I opened my online banking account transactions. I saw a fee for an overdraft charge. Not only was I upset at myself for not managing my cash flow better, but I was upset that the bank would charge me even though I had a direct deposit and a transfer from savings coming in on the same day.
Annual Percentage Rate for a Payday Loan
Let me back up for a second and explain the title. There is a general dislike among personal finance bloggers toward payday lenders. I personally don’t have a problem with them as long as they disclose their fees up front, and with new regulations they have to display the annual percentage rate as well. If you are not familiar with a payday loan, this is how it works. Let’s assume you are living check to check. That means that your check is gone just about as soon as it comes in. The date to renew your insurance gets pushed up by a week, the bill is 100 bucks. You don’t have the money to pay it early because you have no money in savings. You need to borrow money.
Let’s also say you have no credit cards. You cannot go to a bank and get a loan this small to cover this payment so you decide to visit a payday lender. They will allow you to borrow up to what your paycheck will be so that you can pay this bill now. Then when you get your check, you pay them back along with a fee. Let’s say 20 bucks. So for one week, you borrow 100 bucks and you pay back 120. That doesn’t seem too bad for someone who’s in a pinch. But what if when you go back you can’t pay back the 100 dollars? Usually, the lender will allow you to pay another 20 dollars to borrow the money for another 2 weeks. Then you start to spend more money because now there’s more in your budget and maybe another emergency comes up and eventually you are pawning your car. Ok, maybe that’s a little extreme but hey, it happens.
The problem with this cycle is the fees. 20 dollars to borrow 100 is a lot. In fact, it’s down right exorbitant. That’s the word used to describe highway robbery by banks. In one week borrowing 100 and paying back 120, costs you 20%. It seems small because 20 bucks is nothing nowadays and 20% is not so bad either. But if you annualize that number it’s 1042%. Yes, you read that right, over one thousand percent. Right now, the bank can borrow at 0%, most consumers can get a mortgage at around 4%, and even people who are late on their credit cards are paying at most 30% a year. This is why people have a problem with payday lenders. Especially if they are predators and do not disclose the annual rate.
A Bank or Loan Shark?
So now that we have that down, back to my little overdraft situation. I was charged 12 dollars for overdrafting. The overdraft occured at midnight and it happened because I forgot to track a check. (Whoops!) My problem is that I am not a payday loan customer, I am a responsible banking customer, I keep savings to protect against mistakes like this and I stay within my budget. I did not like the fact that I was charged 12 dollars on a 50 dollar overdraft. Using the same calculation as above, that’s 24% for one day. My annual rate? 8760%. I was on the phone immediately and my bank kindly reversed the charge. So I’m writing this to everyone who is hard on payday lenders, the banks are worse. I actually wrote a post about my thoughts on greedy banks.
My solution? I’m making sure to track all checks I write in my Mint account. That way I will always have the most up to date balance. Nothing really needs to change with my checking account. I have a savings balance to cover in case of emergencies. But I also plan to make the switch to ING. I’ve already been following them and I like the Orange Checking account that they have that gives you a simple fee free overdraft policy.
What are your thoughts on this situation? Do you think that banks have more exorbitant fees than payday lenders? Have you ever made a mistake like this and caused an overdraft?