Getting a payday loan is a cinch. All you need to qualify for one is a stable income, bank account, and address. No credit check is required, and the application process is straightforward. As such, a payday loan can be tempting if you need some extra cash to cover a financial shortfall.
Canadians are increasingly turning to payday loans to get by financially. A 2016 survey on payday loan use in Canada conducted by the Financial Consumer Agency of Canada (FCAC) found that 45% of respondents use payday loans to cover unexpected expenses, such as vehicle repairs, while 41% use them to cover everyday costs like utility bills.
Despite their advantages, namely lightning-fast access to cash and lenient eligibility requirements, payday loans are among the most expensive ways to borrow money. If you rely on them too heavily to bail you out each time you’re short on cash, you risk falling into deep financial trouble.Contact David Sklar
Seven reasons to avoid payday loans
Here are seven reasons to steer clear of payday loans.
1. Payday loans come with high interest rates
One of the top reasons to avoid getting a payday loan is the high interest it charges. Payday loan rates often eclipse those found on credit cards, unsecured personal loans, and lines of credit.
Except in Quebec, the maximum interest rate that lenders can charge on a loan is 60%. To any casual borrower, that’s already very high. But this limit doesn’t apply to payday loan companies; they operate under different regulations set at the provincial level.
The Ontario Payday Loans Act permits payday loan companies in the province to charge up to $15 for every $100 they lend out for two weeks.
At first glance, it seems like you’re paying a 15% interest rate. However, converting this amount to an annual interest rate works out to over 390%!
As the FCAC shows, the amount of interest you pay over two weeks for taking out a $300 payday loan is considerably higher than other types of financing:
- Payday loan in Ontario: $45
- Line of credit $5.92
- Cash advance on a credit card: $7.65
- Bank overdraft protection: $7.42
2. Payday lenders charge extra fees if you’re late repaying your loan
Besides the costly borrowing rate, payday loan companies also charge excessive penalty fees. If you fail to repay your loan on time, the lender can tack another fee on your existing balance or charge you interest. They can also apply an extra charge for bounced cheques or declined pre-authorized debits when attempting to withdraw money from your bank account on the due date.
For example, suppose you borrow $300 in Ontario. In that case, the total amount you must pay after receiving your next paycheque is $345 ($300 principal and a $45 maximum fee). But let’s say you have no money in your bank account to cover the loan. In that case, the lender can charge you up to 2.5% monthly on the outstanding balance. They can also add a $20 fee for a dishonoured cheque of a failed pre-authorized debit.
Basically, the amount you owe will continue to grow. What starts as a manageable debt can escalate quickly as the fees mount, making it more and more challenging to pay off.
3. Payday loan repayment periods are very short
You must repay most payday loans in two weeks (the maximum repayment period in Ontario is 62 days). This is an incredibly short time frame compared to personal loans, lines of credit, and other debt products. As a result, it’s relatively easy to miss your payment deadline, especially if other financial obligations consume your latest paycheque.
As mentioned, the consequence of paying late is that your lender adds extra fees to your balance. In addition, failing to repay your payday loan on time will negatively impact your credit score.
4. Payday loans encourage poor money management
Payday loans offer an easy and convenient way to get temporary financial relief during an emergency. However, these advantages are also drawbacks.
The easy access to cash that payday loans facilitate can lead to reckless spending and a habit of excessive borrowing. While turning to payday loans may seem harmless, you risk becoming increasingly dependent on them to bail you out financially whenever you need extra cash. One day, you’re applying for a payday loan to cover an unexpected car repair bill. And soon after, you’re using this short-term financing solution to pay for everyday costs like utility bills and groceries.
If you rely on payday loans to keep you afloat financially, you’ll never learn how to manage your money properly. You won’t build an emergency fund, create a workable budget, learn how to invest, etc. And you’ll be constantly indebted to payday lenders and their costly fees. In other words, your financial house will slowly deteriorate. And if disaster strikes, such as a job loss or illness, it could collapse entirely.
5. Relying on payday loans can lead to a dangerous debt cycle
The combination of high fees and short repayment schedules make payday loans untenable as a long-term solution to financial problems. If you continually take out payday loans, you risk falling into a debt cycle that’s hard to escape. More and more of your paycheque will go toward paying down your balance. Eventually, you may find yourself applying for a payday loan to pay off a payday loan!
The Ontario Government recognizes this danger, so they have made payday loan rollovers illegal. In other words, a payday loan company cannot transfer your outstanding balance to a new payday loan or offer you a new one until you’ve paid off the original in full.
While this law offers consumers some decent protection from the perils of payday loans, there’s a loophole: You can still obtain another payday loan so long as it’s from a different lender than the one that issued your current one. So, if you’re desperate for cash, you can approach multiple lenders to take on several payday loans at once.
In fact, we have had clients with up to fourteen payday loans! Just imagine what it must feel like to owe fourteen payday loans simultaneously and, worse, be unable to pay them. You’ll be on the receiving end of nasty phone calls from fourteen different collection agents. To say the stress would be overwhelming would be an understatement.
6. There’s a chance you could get taken advantage of
In Canada, payday lenders are often frowned upon and have a predatory reputation. While there are bad actors in the finance services industry, scams and shady lending practices are more prevalent among payday lenders. There are three reasons for this:
- Regulations are not as entrenched and well-developed as they are for banks, credit unions, insurance companies, and other financial service providers.
- Payday loan companies are easy to open up and manage. With fewer barriers to entry, there’s more opportunity for unethical lenders to enter the market.
- More and more payday loan lenders operate online, where it’s easier to avoid scrutiny by authorities and regulators. As a result, scam artists have more opportunities to prey on vulnerable borrowers.
Given these characteristics, you could get exploited or scammed when dealing with payday loans. A payday lender may employ deceptive tactics to get you to sign a loan contract that’s misleading or downright illegal. For example, they may understate your fees, charge you a higher rate than legally allowed or deliberately fail to disclose crucial terms in the contract. Those operating online may even steal your private financial details.
7. There are better alternatives to payday loans
Many Canadians are unaware of how much a payday loan will cost them. The FCAC survey we discussed earlier found that 57% of respondents failed to identify that a payday loan balance costs more than one on a credit card or cash advance.
Sometimes, you may feel like there’s nowhere to turn for help when you need money fast. But in reality, a payday loan is only one of many options. There are many alternatives available that are more affordable and flexible, including:
- Getting overdraft protection from your bank
- Asking your employer for an advance.
- Applying for a low-interest credit card
- Selling an unwanted household item online
Check out our list of payday loan alternatives and how they can help save you money.
The bottom line on avoiding payday loans
Payday loans are an expensive way to borrow money—and if you get hooked on them, you risk falling into a debt trap that will be hard to resolve. As a result, they should never be the first option when you need cash. Always explore cheaper alternative borrowing options that offer more flexible payment terms, such as a cash advance, line of credit, and bank overdraft.
Still, borrowing too much money too quickly can lead to severe debt problems regardless of how you do it. The best way to minimize the financial stress that comes with debt is by practicing sound money management. That way, you won’t have to borrow constantly.
Here are some tactics you can employ:
Set up an emergency fund. You won’t need to turn to payday loans (or any other debt) to get you through a financial dry spell if you have ample cash reserve.
Cut costs and create a budget. Review your spending habits to see if there’s room for improvement. Are there areas where you can trim your expenses, such as reducing your bank fees, cutting back on restaurant meals, or getting a reduced rate on your phone bill?
Optime your cash flow management. Just as important as budgeting is knowing how to handle your cash. Strive to match your cash inflows with your cash flows. For example, if you receive a paycheque every two weeks, pay whatever you owe on your bills every two weeks. If you wait to deal with your financial obligations at the end of the month, you risk running short on funds. As a result, you’ll need a short-term loan to cover the gap until your next paycheque arrives.
However, not everyone is in a position to reorganize their finances to avoid payday loans. What if you’re already overwhelmed by these dangerous debts? In that case, it’s time to seek help from a qualified debt professional.
At David Sklar & Associates, we’ve been helping indebted individuals in Ontario get their finances back on track for over twenty years. As Licensed Insolvency Trustees, we focus on long-term solutions to help you get out of debt for good. Learn about your options for payday loan relief in Ontario. When you’re ready to tackle your debts, book a free consultation with us to review your situation. We’ll help you create a plan for breaking free of the payday loan debt cycle once and for all.
Photo by Joël Super