Payday loans are the dirty little debt secret no one talks about, but as many as 2 million Canadians borrow these from these high-interest short-term loans every year.
What is a payday loan?
A payday loan is a loan for an amount less than $1,500 with a term ranging from 14 to 90 days. They typically have interest rates north of 300%, making them some of the most toxic financial products available to consumers.
Payday lenders have been criticized and labeled as predatory since they typically target the economically vulnerable and trap them in a cycle of debt. These loans are marketed as “alternative financing” for people who do not have or cannot get more traditional forms of credit, like a credit card or line of credit. Payday lenders typically set up shop in low-income neighborhoods, where they prey on new immigrants or the working poor who are both low income and have low financial literacy.
If you have never borrowed or do not know anyone who has ever borrowed from a payday lender, consider yourself financially privileged. Or, more accurately, blissfully ignorant. In the province where I live (Alberta), as many as 1 in 3 people have borrowed from a short-term high-interest lender.
Why do people seek out payday loans?
The general assumption of why someone would take out a high-interest short-term loan is the same for why someone would take on any form of debt: to buy things they cannot afford. But the real reason is actually quite depressing.
By and large, most payday loan borrowers are trying to cover the costs of expected necessities like groceries, or avoid late charges on regular bills, like rent, utilities, and car payments. – The Government of Canada
Others are taking out the loans for unexpected necessities, like emergencies. Payday loan borrowers typically have no savings to draw from, and without credit cards, this is their only option when crisis strikes.
The unfortunate reality is someone that did not have the cash on hand to pay for a necessary expense, expected or otherwise, likely won’t have the cash to pay back the amount borrowed plus interest. As a result, it’s not uncommon for a person to take out another payday loan to pay off the first when it comes due. 52% of borrowers use a payday lender more than once per year, with more than 1 in 5 borrowers using the service monthly.
Once you’re trapped in the payday loan cycle, you’re likely to stay there unless an unexpected cash windfall pulls you out.
How much do these loans actually cost?
How much interest a payday lender can charge on their loan varies by region, but 300% to 400% or more is not uncommon. However, these short-term loans are never marketed with their true APRs. Instead, payday lenders sell their loan fees as being “only $25 for every $100 borrowed”, but there can be additional fees and taxes, and this amount quickly compounds if the borrower does not pay back the loan within 7 to 14 days.
The high-interest combined with the short repayment terms drives up the cost of payday loans to astronomical levels. When we talk debt in the personal finance, most vilify consumer credit card debt as the most dangerous, but the cost of borrowing from a payday loan makes even the most expensive cash advance on your credit card look ridiculously affordable.
Here’s a comparison of borrowing costs of payday loans to other types of credit:
Who borrows from payday lenders?
Payday loan borrowers are typically identified as the “working poor”. They are a typically a low or minimum wage worker, earning less than $15 per hour, and still unable to make ends meet even though they often work more than 40 hours per week.
Most payday loan borrowers are men, aged 18 to 34 who have some post-secondary education and incomes less than $30,000 per year – Momentum
But it’s not only the working poor. As many as 20% of payday loan borrowers have incomes greater than $80,000, which means even if the economically vulnerable are being taken advantage of the most, the better off aren’t getting off scot-free.
Most people who borrow from payday loans don’t actually know what they’re getting into. The deceptive marketing combined with the desperation of needing to cover essential bills and expenses in a very short time, lead people to overlook the high borrowing costs. Desperation is a nasty master, particularly when it comes to money, so you can’t really blame someone for turning a blind eye to the hole they’re digging for themselves when they’re out of options.
Usually payday loan borrowers don’t get out of their debt cycle until they resort to the financial last-ditch-resort resources they tried to avoid in the first place, like borrowing from friends and family.
What can you do instead?
If you find yourself in dire financial straits and your local cash store is starting to look appealing, stop. Understand that virtually any other means of covering your financial obligations is a better option, including taking a cash advance on your credit card or taking out a personal loan.
If you have good credit, you have options. It means you can find a low-interest credit card or move money around to cover your bills. If your credit is poor, you have to shove your pride aside and go ask for money from someone who can help you, like a friend or family member. Or you even let your bills go overdue. It might suck to get an angry red envelope in the mail, but a late fee on your cellphone bill is a fraction of the interest a payday lender would charge you, so don’t sweat it too much.
When it comes to helping others avoid the trap of payday loans, it’s a matter of spreading the word of just how toxic and expensive these are loans. Financial literacy is not a silver bullet, but helping people understand the dangers of these high-interest short-term loans and the options that are otherwise available to them can go a long way in helping them avoid falling into the debt trap.
While regulation is getting stricter in limiting these “alternative lenders” from preying on the economically vulnerable, we have a long way to go until they’re gone. In the meantime, Canadian households will unfortunately remain enslaved by their debts until things change.