Q: I'm always hearing how bad pay-day loans are, but I don't understand what the issue is. Sometimes money is tight, and the loan is only for a week or two. What's the concern? - Tamara A: The issue is the cost of the loan. The interest on pay-day loans starts at 300 percent, but because - as you mention - the loans are very short-term, most people don't see it. Let's say you take out a $400 loan for a week. You pay it back a week later, along with the $25 in interest. Doesn't seem too bad, right? But if you do the math, you quickly discover that the $25/week, multiplied by 52 weeks in a year, comes out to $1300, or over three times the amount of your $400 loan. Now if you only did this one time, it might be less of an issue. Except now, the moment your paycheck is handed to you, you get $400 (actually $425) less than you normally would because you have to pay the loan back. If your wages weren't enough to cover your expenses last week, how are those same wages, minus $425, going to be enough this week? Thus it becomes a habitual crutch. And of course, if you make the mistake of not paying the loan back in-full right away each week, there are additional fees as well that quickly add up. Now, we've all found ourselves in a tight spot now and then. It's why I'm such a strong advocate of emergency funds. But assuming you're in such a spot now and have not planned ahead for this particular emergency, there are options. My favorite is going to your nearest credit union for a short-term loan. Loan approval at a credit union is often quicker than at a bank, and the fees are lower, saving you both time and money. But whatever you do, look for financial counseling at the same time. The circumstances that caused this need today could re-appear down the road without a corresponding change in behavior. Q: I have some high-interest debt (around 19 percent), and am thinking about using some of my retirement funds to pay it off since they're only earning about 4 percent right now. Does that make sense? - Vicki A: Vicki, from a mathematical standpoint, I see your point. However, you need to be very careful when making a decision with such significant and long-term ramifications. My primary concern is that once the debt has been paid, your urgency to save or change the behavior that created the debt in the first place significantly diminishes. And without that motivation, you may struggle to save enough to retire the new debt you have...this time, to your retirement accounts. My recommendation to you would be to take a look at the amount you're withdrawing, including any related fees and penalties, and weigh that against the interest that you're saving. In addition, there are any number of calculators available on-line that can give you an idea of how much retirement income that you are forgoing by taking this money out. I would also suggest looking at lower-interest options for paying off the high-rate interest. While a 5.5 percent loan from your local financial institution does have a higher opportunity cost than using the retirement accounts earning 4 percent, they will provide you with a stronger and more immediate impetus to pay off the debt, and will less directly potentially impact your post-retirement years. Going forward, you also may want to re-allocate some of your income. While I applaud the fact that you're obviously saving for the long-term, you don't want to rob Peter to pay Paul. It might make sense to trim future contributions to your 401k or IRA, If you can ensure that those same funds will be used to pay off only your high-interest debt. And of course, make sure that the debt is being incurred for productive purposes.
— Eric Litwiller has spent the last seven years helping people achieve their financial goals through the use of budgets, retirement vehicles and estate planning options. Prior to his current position in fund development at Friends University, he worked for a faith-based financial services firm. He is a firm believer in the importance of using Earthly riches to fulfill a mission of Christian stewardship. He is not a licensed financial planner.