The Payday Loan Trap

Almost all Canadians face financial hurdles to some degree or another — but few financial challenges are as costly or self-perpetuating as the misuse of payday loans. Understanding their intended purpose and affiliated risks is essential.

A payday loan is a type of short-term borrowing where a lender will extend high-interest credit based on your income. Its principal is typically a portion of your next paycheck. They are meant to be a temporary solution and not to be used for ongoing living expenses.

How payday loans work

Payday loans typically cost about 400 percent annual interest rate (APR) or more. If you require $300 before your next payday and access a payday loan, it will cost you about $51 in charges which is equivalent to an APR of 442 percent. You now owe $351 and if you are not able to make that payment on time your options are to default and risk collection or renew, which comes with more fees. You will be charged about $40, increasing your debt to $391 in a very short period of time. If you continue to renew or access additional payday loans from other institutions, you will be sinking deeper and deeper into the payday loan trap. You could end up paying as much as the loan in fees alone.

When you obtain a payday loan, they require your banking information which is also risky because even if you are not able to pay it back at the required time, they can continue to try and withdraw the funds, resulting in additional charges on your bank account.

Understanding your options, and the risks

Consider your options before a payday loan:

1. Contact who you owe money to and discuss a longer repayment period.
2. Discuss your options with your employer, can you cash in vacation days or obtain an advance on your pay?
3. Any family or friends you can reach out to for a loan?
4. Discuss options with your financial institution such as a line of credit, loan, or overdraft.
5. Is there room on your credit card for a cash advance?

Although these options have their own potential downfalls and risks, the interest rates and fees associated with them will be more affordable than payday loans.

If you do end up taking on a payday loan, be sure to fully understand the fees, charges, and interest. Request a copy of the loan agreement so you know when the loan is due and what happens if you are not able to pay it back on time, or if your payment is returned NSF. If you are at the point of accessing this type of credit, you likely can’t afford surprises.

Online payday loans are also available, but many are not licensed and don’t abide by the provincial rules, potentially opening you up to more risks. If you have no other options and must resort to a payday loan, only used licensed lenders. You can contact your provincial consumer affairs office if you want to check if the payday lender holds a license.

Relying on fast cash can lead to a debt cycle; instant cash comes with a price. Accessing these types of loans is not recommended, they may just be a temporary solution to a more serious underlying problem. Often there is a lack of budgeting skills that lead to this type of lending. Managing your finances, budgeting, and having an emergency fund are important and necessary to avoid the payday loan trap. It may be time to look at your monthly expenses to see where some changes can be made.

MNP is here to help

Instead of reaching out to payday loan companies, it might be to your advantage to reach out for help. At MNP Ltd. we offer free initial consultations where we can review your budget with you and come up with options to deal with your debt and avoid the payday loan trap, leaving you in charge of your finances and financial freedom.