Say your car breaks down. And the repairs are going to cost you a few hundred dollars. How would you pay?
In 2022, a Federal Reserve survey found that about a third of Americans couldn't cover a $500 expense out of pocket. There are a lot of bigger-picture reasons for that. But this video is going to look at something really specific: The actual routes that Americans in this situation typically take to get that money.
. . and how much each of them might cost down the line.
That same 2022 Federal Reserve survey described six basic non-cash options that respondents said they would use to cover an unexpected expense. But how available each of these options are to most Americans, and how much they actually end up costing, varies. Let's look at availability first.
Most of these paths require you to deal with some kind of bank or institutional lender, both of which have histories of excluding people without existing lines of credit. If you want to avoid that, you have these two very basic and straightforward options: Sell something, or borrow from someone you know. These routes might have an intangible cost, but they won't require any approvals or credit checks.
. . Unlike the rest of your options.
Borrowing from a bank is perhaps the route with the highest barrier to entry. In order to be approved, you have to have really good credit, and put together a pretty detailed application. .
. and be able to prove you have the income to pay it back. And a lot of banks have a lending minimum of $1,000, which means more money to pay back later, or taking the time to find a bank with a lower loan limit.
Credit cards are slightly easier to get, though it varies depending on the card. About 80% of Americans already have one. But if you don't, it'll take some time to be approved and receive your card.
Same thing for the bank loan. Meaning they might not be viable for covering a time-sensitive expense. And then there are these two: At first glance, you might call them the easy options.
You can go into overdraft, or allow your bank account to go into the negative, which not every bank allows. But if yours does, you generally don't need to apply for it. We'll come back to this one.
Finally, there are payday loans. There are short-term loans, from businesses set up specifically for that purpose, marketed as a sort of advance, bridging the gap until your next paycheck. They are easy to get, and come through fast.
With no credit checks or collateral needed, virtually anyone can be approved, which is why people turned away from the bank and credit system often find themselves here. With all of these paths, there are costs and obstacles. But this one in particular is bumpy.
With Digital Credit Union, you'll get a world of financial possibilities, starting with their award-winning primary savings account and a zero-fee checking account that could help you get your paycheck up to two days early. Like all credit unions, DCU is a not-for-profit, which says its primary focus is to serve their members, unlike banks, which primarily serve their shareholders. From community giveback initiatives, to innovative products and services, their mission adheres to these three principles: People come first, do the right thing, and make a difference.
DCU does not influence the editorial process of our videos, but they do help make videos like this possible. These two are likely to cost you the least down the line. If you sell something, you may need or want to replace that object eventually, but you'll have no outstanding debt, and you won't have to deal with interest or fees.
And if you borrow from a friend or family member, they may not necessarily charge you interest at all. So your interest rate, in bank speak, APR or annual percentage rate, could be zero or close to it, meaning your debt won't grow while you're trying to pay it off. These paths are where it starts to get more complicated.
Generally speaking, when it comes to institutional lending, the easier something is to get, the higher the interest rate, and thus, the total cost will be. But how that debt grows can vary. Take overdrafts.
There is technically no interest charged on these, just a fee, something like $35. But every time you go deeper into your overdraft, the bank will charge another fee. Meaning, if you use the card for even a $1 expense, like a coffee while you wait to pick up your car, it'll cost you another $35.
Bank loans have an average interest rate of about 12%, which is considered fairly low, as well as set payments and loan lengths, meaning you can know how much the loan will cost you from the get-go, as well as how long you have to pay it off. So for a $500 expense, you might pay it off every month over two years and spend in total about $565. There are also fees to apply if you're late or miss a payment, etc.
So that number can fluctuate. Credit card interest rates vary, but let's say yours is 24% -- about average. Unlike loans, payments are flexible above a certain minimum payment.
Say yours is $20. Each month, you can pay anywhere between that and the full balance. If you only pay the minimum the first month by the next month, about nine-ish dollars in interest will be added to your debt.
The more you pay per month, the less you end up spending in the end, and the less time it'll take you to pay it off. But keep in mind, you pay interest on the interest, not just on the original debt. So if you keep paying the minimum, and this $500 is your only debt, it'll take you three years to pay this off and end up costing you $700.
Then there are payday loans. . .
which work a little differently. They're advertised as short-term, meant to be paid off with your next paycheck. But they have exceptionally high interest rates: about $15 per 100 borrowed, or about 400% when annualized.
So in just two weeks, you’ll owe a total of $575. And if you can't pay all of it, you'll basically start this whole process over, and owe an additional rollover fee. .
. all due in just two more weeks. Which is why payday loans are considered predatory, and a third of all US states have outlawed them.
They're basically designed to turn into a debt spiral. The risks and hidden costs of these paths together make a great case for starting your own emergency fund. If you end up having to rely on one of these, a string of bad luck could put you in a really bad position.
And for that 32% of Americans who will need to turn to one of these options, that's a problem the country has yet to solve.
