You don’t have savings or credit card (otherwise, you wouldn’t be thinking about a payday loan).  You’re pretty much living paycheck to paycheck.  Then, you have an unexpected expense.  Since you don’t have anywhere else to turn for quick cash, you opt for a payday loan.  Naturally, the situation hasn’t improved since you first took out the loan and you can’t afford to repay it, so you pay a fee to have it extended.  Then you do it again.  And again. 

State laws prevent you from rolling the loan over too many times, so you take out another payday loan to repay the first.  Within a few months you owe at least $1,000 in payday loans and fees.

Payday loans and cash advances only make a bad situation worse.  Even legislators who voted on payday loans now regret passing those laws.  In several states, like Georgia, laws are being passed to cap the interest rates on payday loans, keeping them in the double digits, at least.

What can you do when you’re in a bind and need cash fast?  Start by preparing for that type of situation.  If you’re reading this and you’re doing ok financially, start building an emergency fund.  Pay down your credit card balances so you have some available credit.  See this article I wrote for About.com Credit/Debt Management “15 Payday Loan Alternatives” more more ways to deal with a financial bind.

3 Reasons Not to Borrow Against Your 401K

If you leave your job – whether it’s voluntary or involuntary – the balance of the loan will be due within 60 days.  If you don’t repay it, you’ll face a 10% early withdrawal penalty and you’ll owe federal and state taxes on the amount you borrowed.

Your paycheck will be less until you repay the loan.  Getting the 401K loan payments taken directly out of your checks is good because you’re less likely to become delinquent.  However, you’ll be bringing home a lower paycheck until the loan is paid in full.  This means, you’ll have to change your lifestyle to accommodate the decrease in income.

You set back your retirement savings.  Typically, you can’t contribute to your 401K until you’ve repaid the loan, so during that time, your retirement savings isn’t really growing.  If you have a retirement goal to reach (which you should), you’ll have to save more after the loan’s repaid or delay retirement.  Not only do you miss out on those extra contributions, you also miss out on the interest payments you would have gotten if you hadn’t taken out the loan.

All Financial Matters does a nice analysis of the cost of taking out a 401K loan.  It includes a lot of assumptions, but the net is a 401K loan costs more in taxes and sets you back in terms of savings.

Alternatives to 401K Loans

Instead of borrowing against your 401K loan, seek some other alternatives.

• Another savings account
• A credit card
• A home equity loan (interest paid is tax deductible)
• A bank loan