People without enough money in an emergency fund are actually *paying* to borrow money explains Paul Haarman. That’s right: Banks, credit card companies and other lenders can charge fees that can add up quickly when you don’t have the cash on hand to pay them up front.
Here’s how it works:
When you don’t have the cash to buy something when you need it, you can borrow from a bank or credit card company and pay interest. If you carry a balance on your credit cards and don’t pay off the balance in full every month, you’ll get charged interest — typically at a rate of 15% or more.
If you use your debit card instead of a credit card and make only the minimum payment due each month, here’s how much extra it will cost to borrow that $500:
- *Fewer than 3 months: an additional $4.50
- *Three to five months: an additional $13.50
- *Six to 11 months: an additional $24.00
- *12 months: an additional $35.50
- *More than 12 months: you probably won’t be able to borrow that much on your debit card.
If you’re not sure if you’ve got enough set aside, here some simple math to help you figure out how much an emergency fund should be. If you earn $50,000 a year and spend $40,000 a year (that’s optimistic!), then you’d need about six months’ worth of expenses saved up in case of an emergency. But if instead of using cash, insurance or investments for emergencies, you use credit cards or payday loans, the fees will cost even more!
Here are some examples of how borrowing money can cost so danged much more than just paying with your own money:
According to the Center for Responsible Lending, a typical two-week payday loan comes with an interest rate of nearly 400%.
Credit card interest rates can range from 12% to over 20%. If you only make the minimum payment each month and it takes three years to pay off your $500 purchase, you will have paid $101.78 in interest.
That’s more than THREE TIMES what you owe if you just save up and buy things as needed!
Here are ways to bring down those numbers:
- Change your mind set about debt. It isn’t evil or even bad — but it does need to be managed well. Don’t let debt control your life, and don’t let others’ behaviors influence your own says Paul Haarman.
- Make a list of what you are currently spending on, and see which categories can be reduced or eliminated without too much impact on your life. You can’t cut ALL three of the following: housing, food and transportation. But look at ways to reduce spending in clothing, entertainment, personal care, insurance premiums, education and charitable giving.
- Avoid using credit cards for daily expenses or small purchases that can wait until payday or you have cash available. Credit card fees tend to add up very quickly if you don’t pay off the balance each month.
If you take a little time now to get your finances in order, you’ll avoid paying hundreds — even thousands — more over time. And isn’t it worth it to know that instead of paying someone else, you’re saving money for an emergency (or a vacation or a new home or anything else)?
How can I pay off my credit card account if I don’t have a credit card?
Pay off the balance on your debit card.
What’s a payday loan and why can’t I borrow money from a bank for my emergency?
A payday loan is an expensive, short-term loan that allows you to get cash quickly until your next payday. Banks will only give you more money if they think its safe enough to lend you their money. In other words, they charge lower fees because they’re not taking as much risk of defaulting on their loans explains Paul Haarman.
If you borrow before you spend, it’s like paying someone else to give you what you want. If instead of using your debit card, bank account or credit card for emergencies, etc., you save up money first and then only spend what is set aside (and not charged on a credit card); this will also make sure that more money stays in your savings account over time.
Don’t pay fees to borrow money when the smartest choice is to save up first! Does something smart with your money by reading through this blog post for ways to avoid debt and fees!