Why Payday Loans Are Risky

Lenders have to disclose their interest and fees, but it isn't always clear what you're really paying. For example:

If a payday lender says you'll pay “only $14 for every $100 borrowed” doesn’t sound too bad… until you do the math.

A $14 fee for two weeks translates to an annual percentage rate (APR) of about 365%.

Compare that to a credit card interest rate at about 23% APR or a line of credit at perhaps 8% APR, and you see how extreme it is.

In reality, a lot of people who borrow payday loans are not actually able to pay it back in two weeks. When the time comes, they may default on the loan, which then allows the payday lender to charge up to 2.5% monthly interest on top of the original fee (plus they can charge NSF fees). They may roll the loan over (if their province's laws allow it), paying the fee again. Or they may pay the loan back but then immeditately need to take out a new payday loan (with the associated fees) to cover their regular bills.

When an individual re-borrows from a payday lender over and over again, this is known as the Payday Loan Cycle. And if the cycle continues for an entire year, they may have paid more than double or even triple the original loan amount in fees by the end of the year. 

Many people don't realize that payday loans have such a high rate of borrowing costs because they assume the loan is subject to Canadian laws regarding interest rates. Current laws cap allowable interest rates at 35% APR, meaning charging anything above that is a crime... with some exceptions. Payday loans are one of these exceptions, if they meet certain criteria (for example, the loan is less than $1,500). They are instead subject to specific rules which currently allow a maximum of $14 in fees per $100 borrowed, though provincial laws may limit it further. In Alberta, the limit of $14 per $100 applies.

As stated by the Canadian government when it last updated the laws regarding interest rates:

"Predatory lenders take advantage of some of the most vulnerable people in our communities, including low-income Canadians, newcomers to Canada, and those with limited credit history—often by extending very high interest rate loans. The current criminal interest rate under the Criminal Code of 60% effective annual rate (EAR) — equivalent to approximately 48% on an annual percentage rate (APR) basis — can trap people in a cycle of debt that they cannot afford nor escape."

Clearly, this logic applies to payday loans. And yet, the exceptions for payday lenders mean they can charge significantly more than a 48% APR. It's no wonder the Payday Loan Cycle is easy to fall into. 

If you're in a cash crunch, here are some safer alternatives to consider:

• Asking for more time to pay the bills you're considering getting a payday loan to cover. Your creditor may be willing to set up a payment plan or offer a payment holiday.
• Cashing in on vacation pay or asking for a pay advance from your employer.
• Borrowing from family or friends. (Make sure to document the loan, including conditions for re-payment and any interest you will owe).
• Getting a loan or line of credit from your financial institution or getting a cash advance on a credit card, at a much lower cost of borrowing.
• Using overdraft protection on your chequing account. While still expensive, this may be a fraction of the cost of a payday loan.

If you aren't yet in a jam, prevent future reliance on payday loans by building a small emergency fund to cover unexpected situations. Even $500 can prevent reliance on payday loans.

If you are already struggling with payday loans, or have other debts you can't realistically pay, seek professional advice. A Licensed Insolvency Trustee can help you with a plan to deal with debt issues, including payday loans.

The bottom line is that while payday loans may seem like a lifeline, they often create more problems than they solve. Before considering one, explore safer, more sustainable options. And if you are already struggling with the Payday Loan Cycle, reach out for help to understand your options.

Charla Smith & Company is a Calgary-based Licensed Insolvency Trustee, serving the Alberta region. We regularly help individuals consider their options when they are dealing with overwhelming debt, including payday loans. If you'd like to explore options for your debt, please reach out to us.

Disclaimer: This publication provides general information and should be seen as broad guidance only. The information contained herein cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon this information without obtaining specific professional advice relating to your particular circumstances. Charla Smith & Company Ltd. does not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.