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Avoid These Bad Financial Habits

Here's a look at some financial bad habits that can eat into your chance of ever getting ahead.

Refund Anticipation Loan (RAL)
These types of loans are sometimes offered by tax preparation companies when you expect to receive a tax refund. Here's how it works: You overpay your income tax all year long and find that you are due a refund of your overpayment when you file your return. But instead of waiting for the IRS to process your return and send your refund, you can take out a RAL the day you file.

The cost is high; there is likely to be a RAL fee of $75 and an administrative filing fee of $75, in addition to your tax preparation fee of about $100. For the typical refund of about $2000 and only receiving your money about a week earlier, that extra $150 amounts to an annual interest rate of nearly 400%.

The refund anticipation loan preys on impatient taxpayers who want their money NOW. But if you e-file your tax return and opt for direct deposit, you would normally receive your refund in about seven to ten days. You've already let the IRS keep your money all year long if you're due a refund - waiting one more week won't hurt and it will save you a lot of money.

Pawn Shops
These shops give you a loan for collateral. Not only do you have to pay back the amount of the loan plus interest, there may be insurance and storage fees tacked on. If you don't pay back the loan plus interest and fees within the time allowed - usually a couple of months - you lose the right to reclaim your item and the shop owner has the right to sell it at whatever price the market will bear.

Say you pawn a $200 ring for $100. After one month, you must repay the loan, with 5% interest and a 20% storage fee. That’s an Annual Percentage Rate (APR) of 300%! Three things can happen after one month:
  • Best result - You pay the $125 in full and gets the ring back.
  • Not-so-good result - You pay the monthly storage fee ($20) and keep the ring at the shop. The shop may charge interest in two ways: 5% on the amount that was due ($125), increasing the repayment amount to $131.25, or charge 5% interest on the amount borrowed ($100) and add the new interest payment to the payment that was due, increasing the repayment amount to $130.
  • Worst result - You don't repay the loan and the shop keeps or sells the ring.
The shop makes money no matter what - either you pay a substantial interest charge to get your item back, or they are able to sell the item that once was yours to someone else for much more than they "bought" it for.

The loan itself is an expensive way to get cash, but you really lose if you don't reclaim your property. Pawn shops will only loan a small portion of the resale value of the item to ensure that they make a profit by selling it if you don't reclaim your property. If you're willing to pawn something that you really don't plan to reclaim, consider selling it outright somewhere else so you can at least get a fair price for it.

Rent to Own
These stores typically sell furniture, electronics, and appliances and prey on consumers with limited means and limited credit histories. But the reason consumers who are a poor credit risk can get "financing" through these stores is because: 1) the store can repossess the items if a payment is missed, and 2) because the consumer will pay over twice what the item is worth over the course of renting-to-own the item.

Though it may seem affordable to furnish an entire room for "only" $10 a week, after 72 weeks it will have cost $720 to own $300 worth of stuff. As a matter of fact, stores with rent-to-own financing services must list the rent-to-own total price and the total purchase price.

A better way is to set up your home is to do it the old-fashioned way - spend within your means. Graciously accept hand-me-downs, and hit garage sales, thrift stores, flea markets, and the classified ads to equip your home with your basic necessities for as cheaply as possible. Then save your money and gradually replace outdated, worn items with the nicer stuff you want as you can afford to. Over time your home will become the beautiful, comfortable nest you want it to be, but you won't break the budget making it that way.

Cash Advances
These are cash loans on your credit card. You can take a cash advance by making a withdrawal at an ATM by using a PIN just like you would with a debit card. Or you can write out one of those "convenience checks" that many card issuers like to mail with your monthly statement - just to give you added temptation to tap your credit line.

If you thought your interest rate on credit purchases was pretty pricey, just read the fine print on the cost of cash advances on your credit card. There is typically a "cash advance fee" of about 3 or 4 percent, and that's in addition to the annual interest rate. Plus, the cash advance interest rate is often significantly higher than the purchase interest rate. And to top it all off, card issuers don't give a grace period for cash advances like they do for purchases - interest begins accruing immediately upon taking the cash advance.

Overdraft Protection
Many checking accounts offer overdraft protection, but be sure to read the conditions. This product is often called "courtesy overdraft protection" but is really just a loan in disguise. The cost is typically about $25 to $35 for each overdraft, and there is likely to be a fee of about $5 for each day the account is overdrawn, amounting to a very expensive mistake.

But no matter how careful we are about keeping the checkbook balanced, sometimes mistakes in accounting are made, or deposits don't go through as quickly as we expected. There are ways to cover those occasional overdrafts without putting a dent in your bank balance.

The cheapest and easiest way is to link your savings account to your checking account. This is the least expensive way since you'll avoid paying interest charges. As long as you have the funds in savings to cover your overdraft, your financial institution will automatically transfer the money to cover your transaction. There may be a small fee of three to five dollars for the overdraft transfer, but it will save you bounced check fees from the merchant and overdraft fees from your financial institution.

Apply for an open line-of-credit, or a revolving personal loan, with your financial institution and link it to your checking account. This works very much like it would if you linked your savings and checking accounts, and the transfer fee is likely to be about the same. But you will pay interest on what isn't paid back right away so pay it back as soon as possible to keep your costs minimal.

As a last resort, you can link your checking account to an existing credit card that you have with the financial institution, but keep in mind that fees and interest charges are going to be similar to "cash advance" costs covered in the section above.

Payday Loans
These are usually unsecured loans for small amounts - up to a few hundred dollars - that borrowers promise to repay on their next payday. The lender may require a few of the borrower's last paystubs to prove their income and employment. The lender takes a post-dated check or a debit authorization from the borrower for the amount of the loan plus interest, and then automatically takes payment the day the borrower gets paid.

Because the loans are so short, the lender charges a fixed fee (finance charge), rather than an interest rate. When this fee is calculated as an annual percentage rate (APR), the cost of borrowing can range from 400% to 1,000% or more.

Let's say you take out a payday loan for $400. The lender requires repayment of the loan within 14 days and comes with a fee of $74.48. However, the lender will not refund any portion of the fee if you paid the debt off early. This means that if you pay off the loan within 7 days, the APR for the loan is 970.90%. If you take 14 days to pay off the loan, the APR is 485.45%.

If you cannot pay the loan on time, the loan is "rolled over" for another two weeks with an additional fee of $74.48. You have already spent $74.48 to borrow $400. Now your cost of borrowing has increased to $148.96 and you're not out of debt yet. Now you owe $548.96 ($400 + $148.96), and your APR continues to climb. Bottom line: many payday loans can wind up keeping the borrower in debt for a long time, due to rolling over loans and taking out new payday loans to pay off old ones.

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Wednesday, 15 July 2020

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