How Do Payday Loans Work?

Have you ever experienced a financial crisis where you didn’t have enough money in your budget for an unexpected expense? In desperate circumstances, you might need fast access to cash! One of the options available in Canada is a payday loan. While the quick and easy process can seem like a painless solution, it could leave you worse off if you’re not careful. In this blog we will answer several questions including: What is a payday loan? How do payday loans work? We will also provide some alternative options to consider during a financial emergency.

What Is a Payday Loan?

A payday loan is a short-term, high-interest-rate loan that you borrow from a lender. The borrower is expected to pay the amount back, plus interest by the end of a two-week period. These loans are provincially regulated and are generally used for short-term financial emergencies. Some examples are Speedy Cash and Cash 4 You.

How Do Payday Loans Work?

So, how do payday loans work? Contrary to their name, it’s not a loan that you receive the money on payday. Typically, you can borrow up to 50% of your expected take-home pay and, while terms and conditions vary, you must pay back the borrowed amount plus interest within a two-week payday cycle. The repayment is often expected as a full, one-time payment.

How Do Interest Rates Work?

An important part to answering this question, ‘How do payday loans work?’ is understanding how the interest rates work. The biggest difference between a payday loan and borrowing from a traditional financial institution is that the interest rates are excessively higher for a payday loan.

Consider this, a bank loan or line of credit from a bank or credit union offer an average annual interest rate of 8%-10%. Credit cards typically charge an annual interest of 12-24%. If a payday lender company charges an average of $51 on a $300, two-week loan, that is a 442% annual interest rate. 

Here you can see how payday lending compares in the same scenario of borrowing $300 and pay it back within two weeks:

Type of Loan	Interest Rate/Terms	Cost
Line of Credit	$5 administration fee 8% annual interest	$ 5.92
Overdraft Protection	$5 administration fee 21% annual interest	$7.42
Cash Advance on Credit Card	$5 administration fee 23% annual interest	$7.65
Payday Loan	442% annual interest	$51.00

 

The tricky part is that for some Canadians, they don’t qualify for loans from conventional sources, making payday lending one of the only choices. If you are careful to read and understand the terms and conditions, this could still be a workable option in dire situation.

What Happens If You Miss A Payment

How do payday loans work if you miss a payment? Missed payments can have serious consequences and can quickly spiral out of control into greater debt. The results depend on the laws in your province (read them here), but these are some of the potential outcomes from a missed payment:

• the lender may charge you a fee if you don’t have enough money in your bank account
• your financial institution may also charge you a non-sufficient fund (NSF) fee if there isn’t enough money in your account
• the total amount that you owe, including the fees and more interest, will continue to increase
• the lender could attempt to contact your friends, relatives, or employer to collect the money
• the lender could send the case to a collection agency, negatively impacting your credit report
• the lender or collection agency could sue you for the debt and even seize your property
• the lender could go to court garnish your wages

Should You Get a Payday Loan? Alternative Options

You can see that with both the significant interest rates and severe consequences involved, they are not all that hassle-free. We recommend that if you cannot guarantee paying back the loan on time, you should consider these other options:

Ask For More Time To Pay Your Bills 
Contact the people or businesses that you owe money to and ask for more time to pay your bills. Offer to write a post-dated cheque for the day you are expected to get paid.

Try These Other Borrowing Methods
If you need the money immediately, here are some less expensive alternatives that won’t charge you a ridiculous amount of interest.

• cash in vacation days
• ask for an advance on your pay cheque from your employer
• get a loan from family or friends
• get a line of credit from your financial institution
• get a cash advance on a credit card
• get a personal loan from your bank or credit union

Get out of the Debt Cycle

Debt is a vicious cycle and it can feel incredibly hopeless – but the good news is it doesn’t have to be. Seek advice from reputable professionals who can offer confidential, non-judgmental advice to help you find the best solution for your financial needs. BIG financial advisors are a great resource for insight. You might also consider an accredited credit counsellor, a licensed insolvency trustee or an insolvency lawyer.

At BIG, we encourage our clients to be as prepared as possible for financial hardship, whether it’s building an emergency fund, saving and investing, or getting a permanent life insurance policy from which you can borrow in an emergency. Our financial advisors can help you find the right insurance and investment solutions to get your finances on track and meet your financial goals. Contact us today to get started on your journey to financial freedom!