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How to Escape the Trap of Expensive Banking
One of the most powerful articles I’ve ever read is “When You’re Poor, Money Is Expensive,” in the Atlantic. The article lays out in incredible detail how easy it is for otherwise stable people to fall into financial crisis and then how incredibly difficult it is to get out of that situation.
The reality of it is that when you fall into a financial hole where you can’t afford to pay some of your bills and you wind up visiting a payday lender in order to keep your roof over your head, you can end up in a very vicious cycle where almost all of your money goes toward simply keeping afloat for the next few weeks.
To make matters worse, you can easily get locked out of the “normal” banking system, as no bank will allow you to open a checking account, meaning that you’re relying on check-cashing services and other expensive propositions just to get the money that you’ve earned, and you have to rely on things like money orders – again, expensive – to send money to people with any degree of security.
In short, it becomes expensive just to do the things most of us do normally.
The story of Alex and Melissa from the article sums up how such things can get started:
“In a flash, their lives changed dramatically. Alex was diagnosed with multiple sclerosis and had to quit his job. Now he walks with a cane. A few weeks later, their young son Jonah was diagnosed with severe autism. Their medical costs suddenly soared as their incomes dwindled. To manage their finances as responsibly as they knew how, Alex and Melissa chose to live on cash. But they weren’t making enough money to meet their bills. Without a credit history, they couldn’t qualify for a bank loan. Desperate for something to tide them over, Melissa visited a payday lender.
“‘In the moment that we needed it, I was glad that it was there,’ she said. But soon, they were both trapped in a cycle of dependency that wracked up more than $1,700 in fees. With one diminished salary and rising medical costs, they couldn’t make it alone. They needed the help of their neighbors to pay off the original loan.
“The amount of that original loan?Just $450.”
The article goes on:
“Alex and Melissa aren’t unique. Middle-class families falling on hard times and grappling outside the traditional banking system are alarmingly common. Approximately 70 million Americans don’t have a bank account or access to traditional financial services. That’s more people than live in California, New York, and Maryland combined. It’s more than the number who voted for Barack Obama (or Mitt Romney) in the 2012 election.
“Instead of direct deposit, many rely on physical pay stubs. Instead of checking accounts, they have to drive to check-cashing services, like Pay-O-Matic. Instead of automatic payments, they drive again across the suburbs to pay utility bills in person. In lieu of a credit history that qualifies them for bank loans, they have a history of cash that is disqualifying. Instead of low-interest loans, they rely on payday lenders whose services can ultimately cost three- or four-times the original loan. And so, replacing the services of a bank on your own becomes a second part-time job, an odyssey of stripmalls, check-cashing storefronts, money orders, prepaid cards, and miles and miles on the road.”
Obviously, this is a disastrous problem for anyone who falls on hard times. It’s a situation that holds the poor in place and makes it much harder for them to climb up the ladder to the next rung.
In fact, that’s how I view it: a ladder. The climb to financial success is like climbing up a ladder, except the bottom of the ladder is actually in the sea. The first several rungs are slick with sea water and kelp, making it very difficult to get a grip and to get a secure enough footing to make it up to the next step. When you get above that level, it’s smooth sailing, but those first few rungs are very difficult. Everything is working against you.
This isn’t just a story in a magazine for me, either. I have friends who have found themselves in this kind of precarious situation; some have managed to claw their way out, while another was only able to do it with significant financial help from a good friend. I have heard and seen the horrors of payday lending and of being locked out of having a checking account.
While there are certainly some broader potential solutions to this problem, whether they come about through legislation of the banking system or just through an entrepreneurial person or a thoughtful non-profit, that’s not what I’m going to look at today. Instead, I’m looking at solutions that people can try right now to help lift themselves out of this mess.
Here are nine strategies that people can take that will help them escape this cycle. I’m the last person that’s going to claim that this is easy. However, I will say that, if you put your mind to it, it is possible to climb up the first few rungs on the ladder.
Strategy #1: Start establishing a positive history on all of your bills
If you want to take the first step up that ladder out of this mess, you need to be standing on a strong foundation, and that foundation is made up of a consistent positive history of paying your bills on time.
There are a bunch of reasons why paying your bills on time is so foundational.
First, paying your bills on time keeps you from paying late fees on your bills. Many, many bills hit you with a $20 or $35 or $50 late fee for a late payment. If you’re in a situation where money is already tight, this can be devastating.
Second, late payments can have a negative impact on your credit. Often, it’s poor credit that keeps you from getting a checking account, so doing what you can to improve your credit is going to help ensure that you can eventually break out of the cycle of check-cashing services, money orders, and payday loans.
Finally, paying debts on time will make them smaller going forward (provided you don’t add more to the balance). Even if you’re just making a minimum payment on a debt, you’re going to reduce the size of the payment in the future (for some debts) and you’re taking another step toward paying off the debt entirely.
You should do everything in your power to stay up to date on all of your bills, even if that means making some hard choices in the short term. You’re better off living in a smaller place that you can more easily afford than a bigger place that really stretches you to the limit, for example.
Strategy #2: Follow up on info provided on your account denial disclosures
If you’ve signed up for a checking account and been denied, the bank should have provided you with an account denial disclosure that explains the reason why you were denied the account.
Most of the time, that reason has to do with personal credit. Banks get reports on your credit history from the credit bureaus and those reports detail when you’ve defaulted on debts and also when you’re excessively late on bill payments. If you have a bad credit report, they’ll deny you an account. Bad marks on your credit report last for seven years, though their impact fades over time as those bad marks grow older.
Sometimes, it has to do with a past history of writing bad checks. Banks subscribe to a shared service called ChexSystems that keeps track of people who write bad checks and if your name appears in that system, a bank will likely not give you an ordinary checking account. This information does go away after five years and banks become less concerned about negative entries as those entries become older.
Whatever the reason, take that account denial disclosure seriously. Make it your goal to address exactly what is stated on that disclosure and do your best to correct it.
Strategy #3: Open a savings account at a credit union with initial deposit
Your best strategy for getting an account in the traditional (read: inexpensive) banking system is to get a savings account at a credit union. In general, credit unions are much more friendly in terms of extending services and accounts to people with spotty banking and credit histories, and savings accounts are usually easier to get than checking accounts (because of the risk of bad checks).
You can start by heading to a local credit union and establishing a savings account for yourself. You’ll likely need some amount in hand with which to make an initial deposit – $100 is probably an ideal amount if you can come up with that much.
Establishing this account serves one big purpose and several smaller ones (I’ll get to the smaller ones in a bit). The big purpose is that it begins to establish a good customer history with that financial institution which you may be able to build upon in the future in order to get a checking account and perhaps even some loans in the future.
The savings account is the first step, though, and it does come with some benefits.
Strategy #4: Keep a balance and add to it occasionally
The first benefit of a savings account is that it can earn a little interest over time. Rather than your money going away, your money in there actually grows. It doesn’t grow fast, mind you, but it does move in the right direction over time.
Another benefit is that a savings account can serve as an emergency fund for you. That means that if you ever find yourself in a difficult unexpected situation, like a car failure or something akin to that, you have cash that you can tap. You don’t have to throw money at a check cashing service or hope that your credit card won’t be declined. You can handle it.
The key to those things is to keep a healthy positive balance in that savings account, which means that not only do you only use it in an actual emergency, but that you also contribute to it on a regular basis. The balance of that account should slowly be going up over time, not down, and if you do need to use it, you fill it back up as quickly as you can.
Strategy #5: Deposit checks into savings, then make a lump withdrawal from it to pay bills as needed
Another really nice benefit of a savings account at a credit union is that it will usually help you break away from check cashing services. Most credit unions will happily allow you to deposit checks from other sources into your savings account, so when a paycheck comes in, you can deposit that money into your savings account. Then, when you need to pay bills, you can pull money out of that savings account to do so.
There is a pretty tight limit on the number of withdrawals you can make from a savings account each month, so if you’re using this savings account as a check cashing tool, you’ll want to withdraw most of the check in one lump sum (leaving a little behind to build up that savings account over time, as described above) and use it for your bills and other expenses.
Doing this not only frees you from the cost of check-cashing services, it also helps you with continuing to build an emergency fund and also establishing a great relationship with that credit union.
Strategy #6: Ask about ‘second-chance’ banking programs
Another nice feature of many credit unions – and some banks – is what is known as a “second-chance” banking program. In this program, the bank will issue you a checking account, but they will put some restrictions on the use of that account.
One common restriction is that they require you to put down a deposit to open the checking account. So, for example, you might put down a $100 deposit to open that account. That money serves as the “last $100” in your checking account in effect, but does not actually appear as part of your balance. Instead, it merely protects the bank in the event that you try to pass a bad check.
Another avenue that some financial institutions follow is to require that you have a savings account with a certain balance in it in order to open that “second chance” checking account. If you’ve been following the other strategies in this article, this part should be easy, as you should already have a balance in your savings account.
Having a checking account is incredibly useful as it removes you from the need to use payment services like money orders in order to pay bills. It also typically unlocks online banking, which enables you to pay bills directly from your checking account without having to buy stamps either. When you can pay a small bill without having to deal with the time and the expense to go get a money order and send out the bill, that can make a huge difference in terms of your financial recovery and your time.
Strategy #7: When you do get a checking account, maintain a buffer
Once you’ve managed to climb a few rungs on the financial ladder, the last thing you’re going to want to do is slip again due to a simple mistake. One common mistake that people make is writing a check and then forgetting about it when they use their ATM card. They draw their account down to a low enough point that the check, when it arrives back at their bank, triggers an overdraft, which is yet another expense piled on people at the margins of banking.
You can avoid all that with one simple strategy: keep a buffer in your checking account. A buffer is a certain amount of cash that sits in there that is intended to never be touched at all. Let’s say you have a $100 buffer in there. Since you’re treating that buffer as untouchable, you essentially treat a balance of $100 as the same as a balance of $0 in your head. When you’re trying to figure out how much money you have left in your account, you just subtract $100 from your account balance.
That buffer can save you in the event of a small mistake. If you accidentally write a check that might otherwise exceed your account balance by, say, $50 and then cause an overdraft … and an overdraft fee … and the potential threat of closing your checking account, instead your buffer just takes care of it. Obviously, if you ever hit your buffer, you need to refill it as fast as you possibly can to avoid overdrafts.
A checking account “buffer” saved me several times early on in my professional years. Even now, I still have a healthy checking account buffer. It’s a great guard against little mistakes that can wind up being very costly.
Strategy #8: Get your credit report and read it carefully
One challenge that’s faced by people who find themselves pushed out of the banking system is that their credit is in bad shape. They have a history of bad credit choices following them around, haunting every financial move they make, whether it’s renting an apartment or applying for a job or trying to get a checking account.
One powerful step that anyone in this situation can take is to simply get a copy of their credit report and study it carefully to find out what’s actually on there. Doing so can give you a very good picture of your credit situation and can provide a foundation for starting to fix those problems.
The federal government runs a website, annualcreditreport.com, that allows every citizen to access their credit report annually. Visit that site and follow the procedures, then give that credit report a thorough reading. Do you know everything that’s on there? Does everything make sense? Or are there things that don’t make any sense at all?
Strategy #9: Clean up all problems with your report
You’ve got your credit report. Most of it makes sense. A few items seem wrong or out of date, and those things are reflecting on you poorly.
Your next step, then, is to clean up those problems. Just walk through each of those items and contact the financial institutions involved. Find out what’s actually going on with each of those accounts.
Some of the entries might be accounts that aren’t even yours. In other cases, your credit report might be providing incorrect information about your actual account. In either case, work with those businesses to have the accounts assigned to the right person or that they’re providing the correct information to the credit bureaus.
For those accounts that actually are yours, do what you can to get the ones that are marked as delinquent up to date. Contact those companies and see what you can do to create a new payment plan or other arrangement to get things in order and get that negative mark off of your history.
If you take those steps, your credit score will naturally rise. Doing this will help you with things like insurance rates, getting an apartment, applying for entry-level jobs, and, yes, getting a checking account.
I’m not going to kid you: This won’t be easy. You’re going to be tackling these things on a low income and probably under a great deal of time stress to boot.
Right now, you have a choice. Do you want a better future for yourself and the people you love the most? Do you want this situation to go on forever? Or do you want better opportunities, with less money and time being drained away into things like check cashing and making payments?
It’s hard. It will probably require you to make a few lifestyle changes, like moving to a smaller place or selling off some stuff from your closet to get started.
In the end, though, it’s going to be worth it. Getting back in the mainstream banking system will save you an incredible amount of time and money.