It’s not uncommon to find yourself in a sudden financial emergency or realize that your pay cheque didn’t stretch quite as far as you needed it to. When considering how to deal with this situation, some people are tempted to consider a payday loan to hold them over. But this is rarely a sound financial solution.
How do payday loans work?
In theory, payday loans offer quick relief when you experience a financial setback. These short-term lenders generally offer up to $1,500 to cover urgent expenses, under the guarantee that you’ll pay back the loan using your next pay cheque. But the reality is, payday loans are a very expensive solution to the problem. Payday loans come with extremely high interest rates and fees, making them one of the most expensive options for borrowing money. Often, Canadians using payday loans find themselves in a never-ending cycle of frequent borrowing and excessive debt, making it hard to stop using payday loan debt.
How much does it cost to get a payday loan?
The Government of Canada payday loans page shows an example of the cost of borrowing $300 for 14 days using a payday loan compared to borrowing the same amount using a line of credit, overdraft protection on a bank account or taking a cash advance on a credit card (refer to the payday loans page to see the assumptions behind these estimates). The following is a summary of borrowing costs assuming you pay the $300 back in 14 days:
- Line of credit – $5.92
- Overdraft protection on a bank account – $7.42
- A cash advance on a credit card – $7.65
- Payday loan – $51.00
With high interest rates and various fees you are required to pay, it can become difficult to get out of payday loan debt if you cannot pay your loan back on time.
Here is how a small payday loan can turn into a much larger amount owed:
- According to the Government of Canada, the payday loan interest rate is approximately 500-600% compared to other forms of borrowing such as a line of credit, a cash advance on a credit card, and overdraft protection on a chequing account
- Beyond interest, you need to pay additional fees that might include a fee to obtain the loan, a fee to activate a prepaid card and additional fees for missing payments
- You must pay back your loan and additional fees typically by your next payday, which does not give you much time. If you are unable to pay, the lender can engage a collection agency to collect the funds, either by suing you or attempting to seize your property. A lender may also attempt to garnish your wages
If you continue to default on your loan, you will have to pay default fees, and your credit score will be negatively affected.
What happens when I use one payday loan to pay off another payday loan?
If you want to take out a payday loan for $300, you will have to pay interest or fees on that loan. However, if you default on that payment and you will incur a penalty on the amount owed. Suddenly, you will owe about $391 due to fees and penalties using the example on the Government of Canada payday loans page.
You can take out one payday loan to pay off another, but it may put you in danger of taking your payday loan debt to higher levels that you cannot manage. With the compounding of front-end fees for obtaining a payday loan, combined with penalties for not being able to repay by your next pay day, using one payday loan to pay off another may cause you greater financial difficulties that are really tough to resolve.
Are payday loans included in bankruptcy?
Payday loans are included if you file for bankruptcy. Payday loans are unsecured debt, which means that the payday lender does not take collateral or assets as security to recover if you do not pay it back. It is loaned based on your ability to pay it back with your next paycheque and your creditworthiness. Learn more about how bankruptcies work in Canada.
What are the payday lending rules in Canada?
Each province and territory has its own rules and restrictions around payday lending. For more information on payday loans and lending rules where you live, visit the Financial Consumer Agency of Canada.
If you’ve taken out more payday loans than you can manage and are looking to get out of payday loan debt, meet with a Grant Thornton debt professional for a free, no-obligation chat to learn more about your options.