Experts: Here Are the Worst Ways To Pay For an Emergency
A recent GOBankingRates survey showed that roughly half the population has no emergency fund and many more have next to nothing socked away in savings for a rainy day.
Whether that rainy day involves a car repair, a broken bone or a job loss, those people will find themselves scrambling to come up with quick cash any way they can.
And some ways are much worse than others.
Financial desperation rarely comes with attractive options, but pursuing money from the wrong source can quickly make a bad situation worse. If you’re in a jam you can’t buy your way out of, avoid these options at nearly all costs.
When it comes to dangerous sources for cash in a pinch, payday loans are in a class by themselves. The debt they saddle borrowers with is so toxic that they’re prohibited in at least five states, according to the National Conference of State Legislators, and they’re highly regulated in the rest.
“Payday loans should be avoided because they come with high interest and fees, often trapping borrowers in a cycle of debt,” said Jason Skinrood, a certified finance expert and loan officer. “You see a payday loan as the only way out of the emergency you’re in, but in reality, it could end up causing more harm than good. Let’s say you borrow $300 to pay for a medical bill. The loan may come with an interest rate of 400%, meaning that you’ll owe back over $1,000, including the original loan amount.”
According to MassMutual, the average payday loan is $375, but the average borrower takes five months to pay it off, which costs them $520 in fees on top of the $375 they originally borrowed.
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Credit Card Cash Advances
Most people know that putting emergencies on plastic can lead to trouble, but not all credit card debt is the same. Standard charging is almost always better than using a card to withdraw cash where none exists in your checking account.
“Cash advances are different from normal credit card purchases,” said Ashley F. Morgan Esq., a debt and bankruptcy attorney in northern Virginia. “The interest starts immediately, even if you pay it off in full by the due date, and it is often at a higher interest rate than normal credit card transactions. This is done because credit card companies understand that people taking out cash advances tend to be in tighter or more difficult situations, which can mean higher risk, i.e., more likely for a missed payment or default.”
Putting It on Your Card
Revolving credit card debt puts the power of compound interest to work against you. You borrow money, the bank charges interest, and then next month you owe interest on the amount you borrowed plus the interest.
It’s not an ideal situation, but it’s one that millions of Americans find themselves in out of necessity.
“Credit cards aren’t the best option, but they may be the only viable option for some people who need to take care of emergency expenses,” said Julie Ramhold, a consumer analyst with DealNews. “However, before opting for this route, try to make sure you have one that’s good for emergencies. Consider one with a low or 0% APR, for example. Even if that perk is only available for a short time, it can help you to get ahead on repaying the expenses before they start to accrue interest.”
Just remember that a single cash advance negates any introductory APR offers, triggering the full interest rate not just on the advance, but on the entire card’s balance.
Borrowing From Your 401(k)
You can probably borrow from your workplace retirement fund but think hard before you dip into your nest egg.
“Most plans allow borrowing from the balance,” said Kyle Enright, president of Achieve Lending in San Mateo, California. “However, this is generally not a preferred option, as the money in the retirement plan is, after all, designated for life in retirement years. You must pay the amount back in five years or pay taxes and penalties. In addition, if you leave the job associated with the retirement account, the loan will come due immediately.”
On top of that, you’re required to pay interest — although, unlike other loans, you pay that interest to yourself — and in most cases, you can’t make any further contributions until you settle up.
Borrowing Against Your Home or Car
Asset-secured loans can be much cheaper than unsecured loans, and they can play a role in a smart overall financial strategy — but not if you risk your assets by borrowing against them out of desperation.
“You might be able to get a good interest rate compared to other methods,” Ramhold said. “But if you can’t pay a credit card bill, the consequences are much less than if you can’t pay a loan against your home or car. In those cases, you could literally end up losing your home or vehicle, and it’s just not worth the risk.”
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