Posted by Lending Club :: November 4, 2010 @ 4:25 am

The following is a guest post by Tim Chen, CEO of NerdWallet, a website that helps you find the right credit card based on your lifestyle, by filtering nearly 600 credit cards to either maximize rewards or minimize APRs.  Tim writes about credit cards for the Forbes Moneybuilder Blog, Huffington Post, and the Christian Science Monitor.

At the end of the month, you're short $150 to pay the bills.  You need that money immediately to keep the lights on, so what’s your best bet? what do you do?

Here are your most common choices:

• Go to your bank's ATM, and overdraft your checking account once,
• Charge it on your credit card, and eat 14 days of interest. For the sake of argument, assume you are paying “Default” APR rates, which are the highest legally permissible,
• Get a payday loan and risk getting charged usury rates.

Pretty grim options, aren't they?  No matter what you do, you'll be paying.  So what's the cheapest option?

Payday loan centers generally have bad reputations for a reason, but in this situation they actually outperform the overdraft option. We’ve done the math for you below.

The numbers speak for themselves - never use “overdraft protection”.  A payday loan is better, and adding it to a credit card balance is an even better proposition if your credit is good enough to obtain one.

If you ever need to do a similar comparison on your own, try an online payday loan APR calculator.

More Reasons to Avoid Overdraft Protection

If you have a checking account, chances are you’ve been getting harassed by spam and bank tellers begging you to participate in overdraft protection. The reason this is happening is because the Federal Reserve found the practice so appalling that they banned it.

Before August 15, 2010, your bank could opt you in for overdraft protection without your consent. This doesn’t seem like a big deal, but when your account is empty, you get charged $35 each time you use your debit card, until you realize something is wrong. Numerous lawsuits have been filed regarding this matter, especially surrounding the practice of banks reshuffling the order of payments to ding you as many times as possible.

Given how lucrative this practice is for banks, it’s not hard to understand why I’ve received at least 15 letters from Chase over the past few months asking me to opt-in, and I’m sure you are seeing much of the same.

There seems to be a serious lack of awareness regarding the issue. Regional banks like TCF Financial claim that most people actually want this service, yet their average checking account gets hit with over $120 per year in overdraft fees. How they’ve managed to get 85% of their new customers to opt-in is beyond my comprehension, given that 5% of people end up paying over $1600 per year in fees, each, according to an FDIC study on overdraft fees. Lack of education must be part of the issue, along with some pushy sales kung fu.

To really nail the point home, Bank of America recently announced that they have ended overdraft protection at the point of sale, because it’s pissed off so many customers. In October 2010 they reported that 10% of customers were paying 70% of the overdraft fees, and that 10 million checking account customers jumped ship last year, largely because they were peeved about overdraft charges.

So Are Consumer Advocates Wrong to Push People Toward Debit?

Contrary to popular opinion, if you need money in a pinch, you actually come out ahead by running up your credit card rather than overdrawing your checking account. So savvy consumers would actually benefit from keeping an emergency credit card on hand. We recommend you ignore credit card rewards though, and get a low APR credit card with a low interest balance transfer offer. The reason this is a smart move is because rewards credit cards tend to have much higher APRs than those targeted for people carrying balances.

Another longer-term strategy for those with good credit is building an emergency cushion with a P2P personal loan.  Peer-to-peer lending has gained quite a following over the past few years because it offers lower rates.  As an example, if you have excellent credit, you could borrow $1,000 from LendingClub.com over the next three years at an interest rate of 5.42%, and that will give you a cash cushion to avoid ever having to overdraft.  At that interest rate, this loan would cost you about $86 plus a $20 fee, or $106.  That’s basically equivalent to three overdraft fees at $35 apiece, so you will likely come out ahead with P2P, while giving yourself enough time to build a cushion of your own.

Regardless of how you finance the loan, be careful not to fall into the cycle of coming up $100 short each month. The reason there are so many payday loan centers is because this happens to so many people, and it’s very good business.