Loans - Why Bank Overdrafts Is a Bad Deal

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Payday Loan - What to Expect
Payday loan qualifications are different from other types of short-term loans. By establishing that you have a monthly income and meet other minimum requirements, you can receive a loan even if you have poor credit.

Established Regular Income

One of the prime requirements for a payday loan is that you have a source of regular monthly income. Most payday loan companies will as... Read loans article



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Today, with the constantly escalating standard of living in the UK, taking a loan is a mundane feature. It is no longer that last sought option. With growing competition, there are innumerable lenders in the UK finance market who can offer various loan options that will suit your pocket. Personal Loans UK are among those that allow choosing your own repayment options in accordance with your loan t... Read loans article



Loans - Why Bank Overdrafts Is a Bad Deal
Many banks actively encourage their clients with low balances to overdraw their accounts. That means, if the customer writes a check or uses her debit card and has insufficient funds in the account, the bank clears the check by granting a temporary overdraft (a short-term loan), up to a specific limit. The customer is saved from the problems of bounced checks or interrupted shopping sprees.

Sounds like a good deal for the customers, right? That's what the banks say. They claim overdrafts are an added convenience to customers.

The truth is, they're often a very bad deal for the customers. Here's why.

When a bank grants a regular line of credit, the interest charged may be up to say, 20% or so. However, for overdrafts, banks don't charge interest -- they charge a flat fee on each transaction. This fee does not depend on the value of the transaction.

Let's see how that works. Overdraft plans fees may be as high as $35 per check. We'll assume a more conservative fee of $20 per check. If you have four checks totaling $200 that have insufficient funds against them and the bank automatically activates the overdraft and clears those checks, you will owe $80 in overdraft charges.

Unlike revolving lines of credit which you can repay at your convenience, an overdraft has to be settled in just a few days. Let's say the bank allows you to run the overdraft for 14 days.

A loan of $200 for 14 days incurring charges of $80 translates into an Annual Percentage Rate (APR) of 1043%!

A "convenience" for customers? Not at these rates.

What does this remind you of? It reminds me of payday loans and cash advances. Those are the other forms of lending which charge you such sky-high APRs. In fact, if you choose to repay a cash advance on due date and not roll it over, you'll likely be charged far less than what the banks charge you for an overdraft.

It gets even worse. Banks have software that ensures that your largest value checks and debits get processed first. There may be some logic to that. However, this arrangement also means that when there are insufficient funds in your account, instead of paying one overdraft charge on one large check, you pay several charges on several smaller checks!

Plus, most customers don't even realize that they are overdrawn until the bank notifies them about it.

Consumer advocates say that banks are perfectly aware that many people barely make it from payday to payday. These customers typically have very low balances. Rather than offer them a service that would be in their interests, banks extract high fees from them to cover bounced checks.

If you are caught short between paychecks, consider arranging funds from other sources rather than turn to overdraft protection. The best solution to the problem is to systematically build up cash balances so that you don't face such a situation in the first place.

About the Author

Prakash Menon is a financial expert and writer specializing in managing personal debt and providing wealth building solutions. He has written on signature loans, personal debt management and other topics.

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Types of Loans - Facts Revealed

When you set out to borrow, you often come across terms like unsecured loans, revolving loans, adjustable rate loans, etc. While these terms are more or less self-explanatory, it is still useful to be clear on their exact meanings and what they imply before you finalize a loan contract.

Unsecured versus secured loans

As the name implies, a secured loan is one where you offer some kind of collateral against the loan. The agreement is that if you default on the loan, the lender has the right (but not the obligation) to take possession of the asset you have pledged.

In most cases, this asset would be what the lender has financed. For example, when you take a home loan, you offer the home as collateral.

There may also be cases where you may need to offer additional collateral over and above the asset that is being financed. This happens, for example, when the lender is financing close to 100% of an asset that is prone to rapid reduction in market value. In such cases, the lender may insist on your putting up another asset so as to provide a reasonable margin of protection in case of default.

Unsecured loans are those where such collateral arrangements do not exist. These loans are granted based on your credit standing, ability to repay and other factors.

In cases where there's a choice available to the customer to take either a secured or an unsecured loan, the former may be offered at a somewhat lower rate. That is, assuming every other factor remains equal. This is because of the lower risk involved to the lender, who has recourse to a specific asset in case you default. However, this situation is comparatively rare in consumer financing, although it is more common in financing businesses.

Installment versus revolving loans

A revolving loan is one where you have access to a continuous source of credit, up to a pre-determined credit limit. If the limit is say, $10,000, you can borrow any amount up to $10,000. And typically, you can repay all or part of the amount you borrowed at a time of your choosing, within the overall tenor of the loan.

You pay interest only on the amount you borrow for the time you borrow it. Sometimes, banks may charge a commitment fee for making a revolving line of credit available to you. This fee is usually charged on the average unutilized amount of your limit.

You can also re-borrow the amount you have repaid. In effect, you have a loan that's always available to you on demand.

Unlike revolving loans, installment loans have a fixed repayment schedule. In most cases, the full amount of the loan is drawn down (i.e., borrowed) at once and both repayment schedule and amounts are fixed in advance. You do not have the option to re-borrow the amount that has been repaid.

Adjustable rate versus fixed rate loans

A fixed rate loan is one where the interest rate charged is fixed for the entire duration of the loan. The advantage is that you are immune to fluctuations in interest rates and can budget your cash outflows precisely. The disadvantage to you (the borrower) is that should interest rates fall, you lose in terms of opportunity costs. That is, you could have obtained a lower interest rate had you opted for an adjustable rate loan.

In practice, you can always choose to refinance the fixed rate loan at a lower rate if interest rates fall sharply enough to justify it. Bear in mind that your current lender may charge a pre-payment fee if you choose to repay before due date. So the difference in interest rates between your old fixed rate loan and the new loan should be large enough to justify a switch.

An adjustable rate loan is one where the interest charged fluctuates in line with a benchmark rate. This benchmark rate is usually the Prime Rate, which is what the US Treasury charges its prime (or best) borrowers. The advantage of an adjustable rate (or floating rate) loan is that what you are paying is more or less in line with the market. If interest rates decline, so do your costs and vice versa. The disadvantage is that your cash outflows for interest are unpredictable.

As a borrower, if you hold the view that interest rates are going to decline, it is best to opt for an adjustable rate loan. But arriving at the correct view consistently is easier said than done. Predicting interest rates is a game where even professional market participants and institutions frequently go wrong.

If it is important to you to be able to budget for your interest obligations in advance, a fixed rate loan may be the best choice. After all, you can refinance it should the interest rates fall significantly.

Keeping these basic facts in mind should help you make more informed borrowing decisions.

About the Author

Prakash Menon is a financial expert and writer specializing in managing personal debt and providing wealth building solutions. He has written on payday loans, personal debt management and other related topics.


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Loans - Why Bank Overdrafts Is a Bad Deal
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