Life happens – we get that. So when an unexpected financial curveball comes your way, the prospect of a payday loan might seem like a saving grace, providing quick and easy access to cash just when you need it. If you’re considering taking out a payday loan, you certainly aren’t alone. The Canadian Consumer Finance Association estimates that nearly two million Canadians a year make use of payday loans.
However, it’s essential to remember that these types of loans can be very risky, and are often more expensive than they seem at first glance. Many of our clients have signed up to our Orderly Payment of Debts program after falling into a debt cycle caused by payday loans. For example, Trevor who ended up with more than $60,000 in debt through payday loans. Or Russell who paid off $35,200 in credit card debt and payday loans.
As we take a deeper dive into the subject of payday loans, we’ll consider both their advantages and disadvantages, and we’ll do our best to keep an open mind. If you are in a situation where you are considering taking out a payday loan, it’s best to make sure you have as much information as possible before making a decision. So, you’re doing the right thing by reading this and staying informed.
Payday loans allow borrowers to quickly access cash to cover short-term needs between pay checks These small, short-term loans seem appealing when you need money in a pinch But are payday loans ultimately helpful or harmful? Here, we dive into the pros and cons of payday loans to help you make an informed decision.
What Are Payday Loans?
Payday loans are a specific type of small, short-term loan targeting borrowers who need money fast. They allow you to borrow a small amount of money, usually between $100-$1000, that is supposed to be repaid when you receive your next paycheck.
Payday lenders require very little to qualify for one of these loans. All you need is:
- Proof of income
- Valid ID
- Checking account
Many payday lenders do not check your credit or qualifications beyond that. The loan term is typically 2-4 weeks until your next pay date
Payday loans are easy to access both online and at physical store locations. Major payday lenders include CashNetUSA, Speedy Cash, Ace Cash Express, Advance America, and Check Into Cash.
Pros of Payday Loans
Despite their criticisms, payday loans offer some potential benefits:
Easy Access to Cash
The biggest pro of payday loans is how easily and quickly you can access cash. In many cases, you can apply online or in-store and have money deposited into your checking account as soon as the same day.
The convenience of accessing fast cash makes payday loans very appealing when you need money immediately for an unexpected expense.
Few Requirements
To qualify for a payday loan, you generally only need to show proof of income, identification, and a checking account. They are available to many borrowers who might not qualify for other types of credit due to issues like:
- Poor credit scores
- Short credit history
- Low income
- Freelance or irregular income
- Bankruptcy or foreclosure history
As long as you have a regular paycheck, you have a good chance of approval.
No Credit Check
Since payday lenders often do not run formal credit checks, these loans may be an option for borrowers with bad credit or no credit history. Approval is based more on income than creditworthiness.
Unsecured Loan
Payday loans are not secured by any of your assets or collateral. Even if you default on repayment, the lender cannot seize your possessions, car, home, or other valuables.
This makes payday loans low risk in terms of losing property. However, default may still damage your credit score and result in collection calls or legal action.
Cons of Payday Loans
While payday loans offer some superficial benefits, the negatives often outweigh the positives:
Very High Costs
The interest rates and fees on payday loans are exorbitantly high, especially compared to other personal loan options. It is not uncommon for payday loans to have 400% APR or higher.
All the extra fees and short repayment terms can rapidly spiral a manageable amount into unaffordable debt.
Considered Predatory
Due to their high costs and targeting of financial vulnerable groups, payday loans are often considered predatory lending. They may trap borrowers in a vicious debt cycle as they take out additional loans to repay the previous ones.
Many advocate against payday lending and argue for more regulation of the industry to prevent exploitation. Payday loans are illegal in some states.
Risk of Being Caught in Debt Cycle
It is very easy to get caught in a continuous debt cycle with payday loans where you have to keep borrowing more to repay the previous loans. Their short repayment term gives little time to improve your financial situation before the next due date arrives.
Rolling over payday loans or taking out a string of back-to-back loans results in accumulated fees and unmanageable high-interest costs. This makes it challenging to ever repay the loans in full and get ahead financially.
May Not Solve Underlying Issues
For many borrowers, payday loans offer temporary relief for deeper financial issues. However, easy access to quick cash does not fix the root problems.
Without improving your budgeting, increasing income, or cutting expenses, you will likely find yourself needing another payday loan as soon as you pay off the last one. It treats the symptom rather than the cause.
Risk of Insufficient Funds Fees
Many payday loan repayment due dates align with your pay date. However, if the lender debits your account before your paycheck deposits, you are at risk of overdraft and insufficient funds fees.
These fees further add to the overall cost of the loan. Syncing up timing with your lender may help avoid this issue.
Potential for Aggressive Collection Tactics
If you fall behind on payments, payday lenders are infamous for employing aggressive tactics like harassing phone calls, lawsuits, using debt collectors, and even threats of jail time.
While illegal, some of these extreme measures still happen. Debt collection activities from defaulting on payday loans can add further stress and damage to your situation.
Tips for Reducing the Risks
If you do opt to take out a payday loan, some tips that may help reduce the risks include:
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Borrow only as much as you can realistically repay with your next paycheck. Avoid maxing out loan amounts approved.
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Have a solid repayment plan upfront rather than assuming you’ll figure it out later. Factor the repayment into your budget.
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If permitted, only borrow what you need and repay early to reduce fees. Do not wait until due date if you have funds available sooner.
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Avoid rolling over or back-to-back loans. Pay off then take a break before borrowing again.
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Look into alternative loan options that may have lower costs like credit cards or borrowing from family/friends.
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Work on improving your budget and financial situation so you don’t need to rely on payday loans again in the future.
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Set up payment reminders and give yourself a few days of wiggle room before the official due date as a buffer.
The Final Verdict
In most cases, the risks and costs outweigh the benefits of payday loans. Their convenience comes at a very high price that is difficult to justify. Payday loans must be approached with extreme caution and care if used.
However, everyone’s situation is different. There are some cases where an emergency cash infusion from a payday loan may be your best option or only option. If you do go that route, take steps to mitigate the risks.
Payday loans are certainly controversial. In the end, do your research and consider all alternatives before deciding if a payday loan makes sense for your personal needs. Proceed carefully and strategically if you go this route.
The Time & Place for Payday Loans
While we would generally advise on avoiding payday loans wherever possible, we do understand that life has a way of putting unexpected obstacles in your path and that for some people, a payday loan may be the only option available IF they can repay the loan on time. Indeed, millions of Canadians turn to these short-term solutions each year. Payday loans offer a lifeline for those in immediate need, with quick access to cash, few qualifying requirements, and a variety of lenders to choose from. The problem is that low-income Canadians are getting caught in a trap. They often need payday loans to cover regular monthly costs like rent, utilities, car payments, and more. Unlike single emergencies, these are structural issues in their finances that aren’t going away soon. As a result, they have to keep borrowing money that they can’t repay for the same expenses they can’t afford, so their overall expenses are much higher and are escalating each month because of late payment fees and interest.
That said, the potential dangers of payday loans should be looked at very carefully. They come with very high interest rates, short repayment periods, and the risk of falling into a cycle of debt. Not paying on time can result in huge fees, unreasonably high interest rates, and damaging impacts on credit scores. If your credit score has already been affected by a payday loan, learn to rebuild your credit.
Understanding credit scores and the fine print of payday loans is crucial for anyone considering taking out a payday loan. Hopefully this blog post has left you better informed about this credit option. If you are still unsure and you have any questions or concerns whatsoever, give us a call. Our unbiased, non-profit credit counsellors will be able to help.
How do Payday Loans Work?
One of the reasons payday loans are so common is that applying for a payday loan is a fairly straightforward process, with less checks and balances than other forms of credit applications. Lenders will normally ask for proof of a regular income, a bank account, and a permanent address. To secure the loan, you might be asked to fill out a form allowing the lender to withdraw their payment when it is due, including fees, directly from your bank account – a process known as a pre-authorized debit. Alternatively, you could be required to provide a post-dated cheque for the total loan amount including fees.
Once your application is approved, you usually receive the funds either through a deposit into your bank account or in cash. In some cases, payday lenders might issue you a prepaid cash card, but remember, it could cost extra to activate and use this card.