Cash Advance = Not a Good Idea :-(

I know everyone has been in a bit of a pickle. Low on cash, bills are due, gas prices are rising, etc. And those paycheck advance places sound quite appealing... you know, "we'll give you money and you can pay us when you get paid"!

I won't lie; I've thought about stopping by one of those places. Here are a few times when it crossed my mind: about 3 months ago I had to deplete my entire savings to pay for a car repair. Another instance is when my employer somehow missed me when doing payroll. Then, I didn't have much in my savings, so I could barely live for those 2 weeks that it took to issue another check :-( So yes, the thought definitely crossed my mind!

An old friend of mine used to go to one of these places, and it didn't seem too bad. Kinda like a very short-term loan. He'd take out $500, and would pay back around $530 when he got paid again.

Being the accountant that I am, and now taking a finance class, it has come up in my textbook. Let me explain to you why I will NEVER go to a cash advance establishment. Hopefully this steers you away as well (I'm not trying to put anyone out of business, but come on!)

First off, you need to understand the 'time value of money'. So let me give you a brief synopsis. A dollar today is not the same as a dollar in the future; you know, inflation and all of that blah! Hence, we need to use the 'time value of money' to value what some future payments are worth today, or what some present amounts of money will be worth in the future. Here's the equation (sorry for getting mathematical with you all, but you'll see where I'm going soon!) for the future value of money:

FV = PV x (1 + r)^t

Now here's the problem: you walk into one of these cash advance places, and you want to take out $150 for incidental expenses; just to hold you over until the next pay period. In exchange for this $150, you write the establishment a check for $180. The agreement is that you'll pay back the $180 in 15 days, and this doesn't seem like a large amount of cash to repay. I mean, it's only $30! But at what rate are you paying for this money? How much interest are you paying? We'll use our equation:

So, the FV is the amount you're repaying which is $180, PV is the amount you're getting today which is $150, t is equal to 1. Let's plug and chug:

$180 = $150 (1 + r)^1 ----> divide both sides by $150
1.20 = 1 + r ----> subtract 1 from both sides
.20 = r or 20%

20% doesn't seem so bad, does it??? But remember this is for borrowing the money for only 15 days! What does this mean??? That the annual percentage rate (APR) is RIDUNCULOUS!!!

APR = .20 x 365/15
APR = 486.66%

Yes, you read right! That measly 20% for 15 days equates to 486.66% a year!

So, let's see: you borrow that same $150 on January 1st, 2010. If you don't make any payment until December 31, 2010, this is what you'll be paying:

PV = FV/(1 + r)^t
$150 = FV/(5.86666)^1
FV = $879.90

Yes, that's right, you'll be paying back nearly $900 just for borrowing $150!!!

That makes me think twice about credit cards too, and no... I won't be stopping by any of their convenient locations. $900 just about covers one class at my university. NO THANKS!