Payday Loans: Pros and Cons
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.
What is a Payday Loan?
A payday loan is a form of short-term credit, seen by many to be slightly dangerous due to the high fees and interest rates that are often part of the repayment. Sometimes referred to as a high-cost loan or high-cost credit, payday loans allow you to borrow up to $1,500 and usually allow you up to 62 days to pay it back.
However, payday loans are in a credit category of their own and there are a few things that set them apart:
- They’re designed for short-term needs, usually over the course of a few weeks.
- Qualification doesn’t always depend on a credit check.
- Instead of an interest rate, you’ll pay a flat fee, as long as you repay the loan on time.
- The repayment schedule is usually designed to align with your paydays.
- When your next paycheck arrives, you’ll be expected to repay a portion or all of the loan, depending on the agreement reached. Please be aware that if you fail to pay on time, additional fees and interest charges will pile up, and your financial situation can become unmanageable quite quickly.
- Not all lenders are created equal and it’s important to confirm that the lender you are considering is a licensed payday loan lender.
How do Payday Loans Work?
Applying For a Payday Loan
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.
Repaying a Payday Loan
Repaying a payday loan can sometimes be just as simple as applying for one. Some lenders require you to repay your loan at the same location where you got it. Before you take a payday loan, you will be asked to sign an agreement that generally details the loan amount, fees, payment schedule, and due date. It is very important to read this agreement thoroughly and ask about anything you don’t understand.
What Happens If You Can’t Repay a Payday Loan?
If you can’t repay a payday loan, the consequences can be quite serious and may lead to a dangerous debt cycle. In the first instance, the payday lender may charge you a fee if there aren’t sufficient funds in your account. Your financial institution might also levy an insufficient funds fee (NSF). Moreover, interest can accrue on the outstanding amount, and the total sum owed can continue to increase drastically. It is critical to understand that the interest rate can sometimes be as high as 300% to 600%.
In worst-case scenarios, your debt could be sent to a collection agency, which could then appear on your credit report, or the lender or collection agency might sue you for the debt.
Let us help
If you think you may have difficulty repaying a payday loan, the best thing you can do right now is to give us a call. Our unbiased, non-profit credit counsellors have years of experience helping people with these kinds of loans and will be able to assist you right away.
Pros & Cons of Payday Loans
| Pros of Payday Loans | Cons of Payday Loans |
|---|---|
| Quick Access to Cash: Payday loans can often be obtained relatively quickly, sometimes within the same day. This can be helpful in an emergency situation. | High Interest Rates: Payday loans often come with very high interest rates, making them a more expensive and risky form of borrowing. |
| Easy to Qualify: Lenders often don’t require a credit check, making these loans accessible to people with poor or no credit. | Short Repayment Period: Payday loans usually must be paid back by the borrower’s next payday, which can be a challenge if someone is still facing financial difficulties. |
| Few Requirements: Generally, the only requirements are proof of income, proof of address and a checking account. | Risk of Debt Cycle: If a borrower cannot pay back the loan on time, they may need to take out another payday loan to cover the first, potentially leading to a cycle of debt. |
| Lender Choice: There are many payday lenders, giving consumers different options to choose from. | Potential for Scams and Exploitation: Some payday lenders may not follow best practices or may be outright scams. |
| Potential Solution for Emergencies: If used responsibly and paid back on time, a payday loan can help in a financial emergency. | Negative Impact on Credit: If a borrower fails to repay the loan, it could be sent to a collection agency, causing a serious blow to someone’s credit score. |
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.
Frequently Asked Questions
Do Payday Loans Affect Your Credit Score?
Payday loans do not affect your credit score unless you fail to repay on time. In which case, the payday loan company may refer your case to a collections company, which will negatively impact your credit score.
Is it Bad to Have a Payday Loan?
We would always advise people to avoid the use of payday loans if they can. They come with high fees and interest rates and can cause a debt cycle when not paid on time. However, we also understand that they can be a lifeline for some people, so we never judge clients who use them. The most important thing is that you fully understand the terms and that you repay them promptly.
What are Payday Loans Meant for?
Payday loans are designed for short term needs. For example, if you have an emergency and need access to cash quickly. They are usually set up so that they can be repaid by the time the borrower receives their next paycheck.
Can You Have Two Payday Loans at Once?
Yes, you can have two or more payday loans at once, just not with the same lender. However, we strongly recommend against multiple payday loans as this is how clients end up in the payday loan cycle. An unfortunate common scenario is when someone cannot pay back their loan so they take out another payday loan from a different lender in order to pay back the first lender. Some companies will also provide a payday loan and an installment loan instead.
Can Debt Consolidation Help With Payday Loans?
Yes, you may be eligible to consolidate your payday loan debt. There are several options available, including the Orderly Payment of Debts program for Albertans. Our unbiased credit counsellors can help you decide which option is best for you.
Additional Resources for Payday Loans
- Canadian Consumer Finance Association (formerly Canadian Payday Loan Association)
- Government of Canada: Payday Loans: Market Trends Survey
- Government of Canada: Resources – Payday loan companies
- Alberta Government: Payday Loans – Overview & Regulations
Have questions?
Need more information or want to talk to an accredited financial counsellor for peace of mind? Let us help.
Call 1-888-294-0076 or book an appointment. It’s free for all Albertans.
