This is a real check for $6,000!

Because I have not yet performed the opt-out prescreen, I still get credit card and loan offers in the mail. I usually shred them without looking. Today I opened one on a lark. Holy cats, this is a terrible deal. Who signs up for these? Let’s take a closer look at why these offers should be avoided.

The letter starts with a tantalizing offer:

$6,000 for anything? To make my life more rewarding? Even for unexpected expenses? Nearly any other choice is better than accepting this loan. And there are better ways to cope with emergencies. Here’s the deal in its entirety:

[thumbnail of loan offer for $6,000]   [thumbnail of terms and conditions]
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This loan is activated when I deposit the enclosed $6,000 check. Upon activation, I am immediately hit with a $50 annual fee.

This brings my loan balance to $6,050. How much interest am I agreeing to pay on the loan?


Click thumbnail to open full-size image in new window.

I am agreeing to a monthly periodic rate of 2.916%, which is equivalent to an annual percentage rate of 34.989%. I’m taking out a loan with 35% interest. And what about the minimum payments?

Minimum payments are 3.405% of the account balance, just a half a percent more than the monthly periodic rate. The minimum monthly payment is $205, about $175 of which is interest. It’s going to take a long time to pay this debt.

At least the loan company is upfront about what they’re doing. The terms are clearly stated. There are no outrageous claims. The opt-out information is easy to locate. Basically, a consumer would have to be a fool to take this loan, yet there are many who probably do. Why? Because most people lack fundamental personal finance education. They don’t understand what it means to take out a $6,000 loan at 35% interest.

(This is actually the sort of thing I used to consider back when I was broke, outspending my income. I believed these offers were a great way for me to get back on my feet. They’re not. They only put people further in debt.)

If, instead of accepting this loan, you were to take the roughly $200/month minimum payment and deposit that into a savings account, you’d have a $1,000 emergency fund in just five months. You’d have a $2,500 emergency fund in just over a year. And you wouldn’t owe anyone money, wouldn’t have thrown away more than $2,000 to interest.

I know there are times you get in a bind and you need money now. The best thing you can do to cope with these situations is to build an emergency fund in advance. If you don’t have at least $1,000 saved for unplanned emergencies, please make it a priority.

This article is about Choices, Debt  Monday, 25th September 2006 (by J.D. Roth)