The High Costs of Being Broke

I’ve talked before about doing “ramen math” in college, when I was so broke I calculated exactly how to spend every last dollar and on paydays had to write a bad check to have enough gas to get to the bank to deposit my paycheck. I had to risk beating the gas station’s deposit to the bank with my own and if I missed? Bank fees, bounced check fees, even potentially criminal charges. At the time I had so little money there was no other option. My “ramen math” days taught me a lot of lessons but none was more important than this simple fact: being broke is really expensive.

The reality in America (as in most places) is that having more money is better than having less. That seems comically obvious but it means more than its face value: when you have money, it’s much easier to get more money. When you don’t have a lot of money you get charged fees and expenses simply because you don’t have more money. What costs are there to being broke? Read on…

Fees, fees, fees

The number one cost of being broke is all the fees you pay that people with access to more cash never (or rarely) have to pay. It starts with your banking institution which charges you a maintenance fee for not having certain amounts of money in your account (literally a fee for being too poor). If you inadvertently withdraw too much money on your debit card? They hit you with a fee. If you don’t use your debit card a certain number of times each month? They hit you with a fee. If you want to take money out of your account, like at an ATM? You get hit with another fee just for trying to access your own money!

Bank fees and restrictions can be so usurious that some 10,000,000 households in the United States don’t even use them. For those families it’s simply out of the frying pan and into the fryer. Not having access to a bank means needing to purchase pre-paid cards to access money in a non-cash form; of course all those cards have fees costing you a percentage of your money up front. Depositing a paycheck means going to a check cashing store which charges you a fee to access your money. If you’re short on cash? Your only options are pawnshops and payday lenders which offer interest rates that make credit card companies look generous.

All of this amounts to an incredibly expensive cost to living paycheck-to-paycheck. In a worst-case scenario it can lead to cyclical poverty in which you have to get a payday loan in order to pay your bills, but the interest charges mean you’re shorter on your next paycheck then you were on the last so you have to get another payday loan. These expenses are the costliest part of being broke because they can put you into a cycle that’s very difficult to get out of potentially stranding you for years with lack of access to cash and costing you thousands of dollars.

Interest

For approximately one-third of Americans the answer to not enough cash is buying on credit. That’s how many of us have revolving credit card debt meaning we pay interest month-to-month to a credit card company. What’s the impact? Those interest fees are like compound interest in reverse which means you have the world’s most powerful force working against you.

For millions of us we lack the savings to protect us from a sudden large expense (whoops, clutch just went out in the car!) meaning we have to turn to Visa, Mastercard, or American Express. They’re happy to give us the credit to make the payments now but if you can’t afford to reimburse them by your next billing cycle you start paying the juice on their loan and it ain’t cheap. For those who can afford to pay credit cards turn into a valuable cash generator giving you a percentage back on money you were spending anyway, lots of frequent flier miles, or other perks (remember: having more money makes it easier to get more money). If you’re broke? Sorry bub, you eat a loss on a big chunk of your income every month because your car broke down last year.

Like the payday lending cycle credit card debt is a particularly dangerous cost for being broke because it can put you into an impoverishment cycle that becomes increasingly difficult to get out of.

Paying extra taxes

The United States income tax was built on the notion of being progressive, charging people with more money a greater amount than people with less. In practice? Once again, having more money makes it easier to get more money in the form of tax deductions and tax credits. I’ve already presented a case study of one family who earned $100,000 but managed to only pay $11 in taxes! That’s an effective tax rate of just .01% on income that should have garnered a tax rate of 25%! Why is it that a family that earns so much (nearly double the median income for all households in the United States!) can pay so little in taxes? Simple: the more money you have, the more tax breaks you qualify for.

The United States doesn’t provide much of a social safety net for retirement, unlike our neighbors in other countries on continents like Europe. That means we have a somewhat lower tax rate but to provide for people in retirement our tax code is structured to incentivize people to use their income to save for retirement. In the case of the Saver family I cited in my hypothetical case study up above they managed to save tens of thousands of dollars in taxes using deductions, which lower how much money you earned and thus how much income you’re being taxed for, and credits, which lower the total amount you owe in taxes.

So what happens when you’re poor? You don’t have the $5,500 to set aside for an IRA, or the $18,000 to set aside for a 401k. Putting money into your HSA? Not a luxury you can afford. As a result, all the money you earn that you don’t invest in these accounts costs you taxes. That’s how a person earning $45,000 each year can pay a much higher tax rate than our hypothetical family making $100,000.

Losing out on magic dollars

I’ve talked about magic dollars and how compound interest is the most powerful force in the universe already today but I’m going to call it out again. When you’re broke and unable to take advantage of tax advantaged savings programs you’re losing on the gains from interest they generate you over the years. In our example from the Magic Dollars piece even doubling the amount you save later in life doesn’t let you catch up to the money you lose from not saving early on. Compound interest, or what happens when the money you invest earns you money which in turn earns you more money, is truly the most powerful force in the universe but it needs time to go to work for you. When you’re broke and unable to save for the future you’re sacrificing time that could go towards compounding and earning you more money and that is very, very expensive.

Turning things around

By now we understand the many costs associated with being broke. So how exactly do you turn a financially distressed situation around to avoid paying the expenses associated with not having enough money? Better yet, how do you turn on the benefits of having more money?

The 10 steps

If you haven’t yet, take a look at my 10 Step Plan to Your Financial Future. You absolutely need to understand where your money is going so you can begin looking at how to cut your expenses, start paying down high interest debt, and begin working towards saving up your emergency cushion and emergency fund. Following the steps will take you a long way towards improving your financial predicament and putting you into a position where you cut a lot of the extraneous costs of being broke.

Emergency savings

Having money set aside for a rainy day is so important it makes up one-fifth of my 10 Step Plan. Why is it so important? Because it’s key to saving yourself many of the fees you’d otherwise pay when you lack money. Take the example of your emergency cushion, the $1,000 you save up in step two of the plan. By having that money set aside you ensure that if a sudden, unexpected expense comes up you have some wiggle room to pay for it. A broken car window? A sudden cavity? A lost day at work taking care of a sick kid? As little as $1,000 set aside means that in each of those circumstances you can pay for the expense without taking a high-interest loan from your credit card company or a payday lender.

Things get even better when you can fully fund your emergency fund, covering 3-6 months of your living expenses. This is such a powerful means of breaking free from the “being broke” cycle that I’ve called it the best career decision you’ll ever make. Having a fully funded emergency fund means that instead of a broken window you’re prepared for your entire car to go out of commission. Instead of paying for a cavity, you could pay for a mouthful of root canals. And if you lose your job? You don’t have to “settle” for whatever comes your way as quickly as you can; instead, you can afford to look for a while knowing that you have 3-6 months of expenses covered until you really need to find another place of employment. That means finding a better job without the stress of missing bills and falling back into the endless cycle of high interest lending.

Cutting expenses

John Barrymore once asked, “Why is there so much month left at the end of the money?” It’s a pretty funny quote that belies a pretty simple cause: spending that out paces income. It’s the age old evil that causes you to be broke in the first place. So how do you stop it? Pretty simply: cut down on your expenses. If this sounds challenging I promise you it’s not as hard as you think once you consider the fact you can use the most powerful finance tool in the world for absolutely free.

Get yourself a budget (follow that last link) after you complete the first step in the 10 Step Plan and know where your money is going. Your budget will allow you to determine for yourself where you want your money to go each month and before you huff off angry that a budget means “you don’t get to spend money on anything fun,” remember this: a budget is simply you prioritizing what you want to spend your money on. If you’re satisfied paying a payday lender 400% in interest so that you can keep subscribing to the crystal-spider-of-the-month club that’s up to you. If you’d rather not be broke, then use your budget to determine better areas to put your money and start getting yourself out of broke territory!

Increase earnings

Hand-in-hand with cutting your expenses on the path to making sure you have sufficient money at the end of your month is increasing your earnings. Again, this sounds harder to do than it actually is and it’s a key part of getting yourself out of the cycle of paying high fees for being broke. Get yourself a side hustle by picking up work on the weekends or after hours. Take a close look at all the items you have around the house and determine if you really need all that clutter or if you could generate some extra income by selling some of those things on Ebay. Pick up a part-time job until you’ve fully funded your emergency fund and gotten yourself out of a situation in which you’re relying on predatory lending to make ends meet. Does it mean more work for you in the short-term? Yes, but that’s a much cheaper price to pay than the incredibly high costs of being broke long-term.

The moral of the story

Being broke is crazy expensive, while having money is a great way to get lots more money. So pick which position you’d rather be in: earning money simply for having money, or paying money simply because you don’t have money. If you’re currently in the cycle of being broke don’t despair; follow the advice laid out here to start working yourself out of the situation. And absolutely don’t wait; every day that goes by in which you’re broke is just hundreds of dollars more you’re spending in penalties for not having more money.