Sometimes you’ll have a line of defence like an emergency fund or line of credit, but not everyone has access to these resources, and a payday loan might seem like the best option.
It’s rare that users tap into payday loans for a one-time financial emergency, quickly pay the loan back, and get their financial life back in order. In reality, using a payday loan just once is all it takes to get caught in a cycle of debt that ends up costing thousands of dollars in interest charges and fees. Read on to what are payday loans, why payday loans are bad, and how to avoid payday loans altogether.
What Are Payday Loans?
A “payday loan” is a short term loan that you take out and pay back when you get your next paycheque. Because you pay it back on payday, most payday lenders require you to have a steady income to qualify. You can borrow up to $1,500, but whatever amount you borrow, you must pay back the loan on your next payday, and most lenders will require you to fill out a form (called a pre-authorized debit) that authorizes the lender to withdraw the loan amount from your bank account.
Some provinces have mandated that you have up to 62 days to pay your loan back, including:
- British Columbia,
- New Brunswick
Failing to pay back your payday loan on time will result in extra fees and interest charges, which will increase your overall debt load.
How Do Payday Loans Work?
You can apply for a payday loan through private lenders either online or in person, and these lenders will approve you instantly. Some lenders may even pay you cash in person, while others will deposit the funds into your chequing account. You can borrow up to $1,500 from a payday lender, but many of them charge a fee per $100 that you borrow. The most they can charge is $15 per $100 borrowed.
Payday lenders will extract their payment from you via the pre-authorized debit agreement, even if you can’t afford to pay the loan back. If you can’t afford to pay the loan back, you might need another payday loan to make ends meet, which will result in more interest charges and fees. This cycle of borrowing and repaying can make finding your financial footing difficult or impossible.
How to Avoid Payday Loans
Payday loans are the most expensive way to borrow money in Canada, and you should avoid payday loans at all costs. Before resorting to payday loans, here are several options that will be less expensive and less likely to land you in financial hot water.
Get Your Paycheque Earlier
If you need cash fast and you’re days away from getting your paycheque, there is a way to get an advance without paying out the nose: KOHO Early Payroll.
KOHO is a free pre-paid, reloadable card and integrated app that lets you earn cash back rewards on your purchases and interest on your balance. You can also avoid payday loans by accessing KOHO’s Early Payroll feature. If you set up direct deposit with KOHO, you can access up to $100 of your paycheque three days early. The best part about Early Payroll is that there are no fees and no interest to use this service, making this a cheap option. Read our in-depth KOHO review for more information.
Cash Advance On a Credit Card
Withdrawing cash directly from your credit card is another option if you need money before your next payday. Cash advances accrue interest immediately – there is no 21-day grace period like there is for charges – and the interest rate is usually higher than your regular purchase interest rate, but still lower than a payday loan.
Luckily, there are some low interest credit cards in Canada that have decent cash advance interest rates. For instance, the HSBC +Rewards™ Mastercard® offers an interest rate of 11.9% on cash advances. That’s a heck of a lot less than the 391% interest you’d pay on a payday loan!
If you have a short-term need for cash, overdraft protection can be a lifesaver. An overdraft occurs when the balance in your chequing account is not sufficient to cover the charges levied to the account. Rather than decline the charge, overdraft protection charges you a fee for the account to be in a negative balance. Pro-tip: there’s no monthly Overdraft Protection fee with Scotiabank’s Ultimate Package chequing account.
Lines of Credit
A line of credit from a traditional lender (like the best banks in Canada) offers a way of borrowing money at a low interest. Lines of credit are a revolving credit tool, like a credit card, so you do not have to pay back the entire balance immediately. If you have a decent credit rating, you should be able to qualify for a line of credit, and it’s a good idea to have one available in case of a financial emergency.
Debt Consolidation Loans
If you’re deep in debt or stuck in the payday cycle, think about getting a debt consolidation loan. With just a few clicks on your computer or mobile phone, a reputable online loan platform like Loans Canada can provide quotes from top lenders at interest rates as low as 2.99%. Same with Loan Connect: a single search can link you with a large network of lenders and get you fast cash in as little as 12 hours. Interest rates start at 4.6%, depending on your credit history and income.
If you have bad credit, LendingMate is worth considering. They provide guarantor loans where a trusted friend or family member would make loan payments when the borrower doesn’t pay. While the interest rates are very high (34.9% to 43% depending on what province you live in), it is still lower than payday loans and you can get a loan of up to $10,000, even with bad credit ratings.
Why Are Payday Loans Bad?
As we mentioned, payday lenders charge fees, up to $15 per $100 borrowed. While this might not seem too excessive, consider that it will cost $45 to borrow $300 for two weeks, which is the equivalent of an interest rate of 391% (this handy payday loan interest rate calculator is available for your calculations).
This interest rate is sky high, much higher than any other type of lending product in Canada. Here’s a comparison of the interest rate you would pay when borrowing $300 for 14 days from several different types of lenders, including payday loan lenders.
Loan type Interest charged Interest rate Credit card cash advance $3.22 28% Line of credit $0.92 8% Overdraft protection $2.41 21% Payday loan $45 391%
Payday loans only seem reasonable when you aren’t comparing them to other sources of cash.
Sure, the prospect of instant cash might be appealing, but it isn’t worth the higher risk that comes with the extremely high-interest rates – especially if you aren’t sure if you’ll be able to pay off the loan right away. If you can’t pay off the loan on time, you’ll end up paying fees and interest on top of the fees and interest you already owe, and very quickly the balance owing can get out of control until you can’t pay off your loan at all.
Not paying off your loan results in some severe consequences, including:
- You may be charged extra fees if there isn’t enough money in your account
- Your bank might also charge you a fee if there isn’t enough money in your account
- Your total amount owing will go up
- Your lender could begin to contact you and your family to try and collect on their loan
- Your lender could sue you or send your debt to collections
- Your lender could ask the courts to garnish your wages to get back what you owe
- Not repaying the loan can negatively affect your credit score.
The Final Word
Financial emergencies happen to everyone, and even if you’ve saved an emergency fund for financial hardship, you might find yourself in the awkward position of choosing which financial product will do the least damage to your net worth. If you are considering payday loans to make ends meet, we strongly encourage you to remember why are payday loans bad and try one of the alternatives listed above first. Payday loans and the interest associated with them can lead to severe hardship and even legal trouble, and they are rarely worth it to access fast cash.