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What are Payday Loans?
Payday loans are very short-term loans, which can range from a couple of hundred dollars to $1,500. The repayment term is usually on the next payday, and hence the name. For example, a payday lender will lend you $300, and on your next payday, you pay back $350, with the extra $50 being the interest.
Why do people use Payday Loans?
Payday loans are considered “bad credit loans” i.e. for people who are turned away by traditional banks due to their credit history. Usually, payday lenders have very few requirements- mainly having a bank account and some sort of income whether it be employment income or government benefits. People may turn to payday lenders if they are in a financially tight situation and want some cash to tide them over till their next payday.
Why are Payday Loans “bad”?
Payday lenders are notorious for very high interest rates. As an example, the $50 interest on a $300 loan over a period of 30 days translates to roughly 200% annual rate. Compare that with 3-20% annual rate of banks and credit cards, and 20-45% charged by alternative financial lenders, and you can see the difference.
| Payday Loans | Installment Loans | Credit Cards | |
|---|---|---|---|
| Interest rate range | 200%-600% | 6%-44% | 3%-29% |
However, it has to be acknowledged that payday lenders do fill in the gaps left by other traditional lenders like banks- i.e. quick access to cash.
Taking a payday loan once in a while in case of extreme emergencies may be okay, but the problem arises when you find yourself unable to pay for them, or if you find yourself taking payday loans frequently. Many people fall into a cycle of payday loans where they take on a newer payday loan to pay off the previous one. This results in a debt cycle from where it is hard to get out.
Alternatives
A payday loan should be a last resort in case of emergency. Avoiding payday lenders does require some foresight, like building emergency savings and maintaining good credit for easy access to affordable loans. Consider the following alternatives before deciding to take a payday loan.
1. Emergency Savings
This is the time to dip into your emergency savings instead of going to a payday lender.
2. Friends or Family
If it is a small amount, you can ask a close friend or family member for help. But make sure that you do repay them.
3. Bank Overdraft
Having a bank overdraft protection will ensure that your cash transactions will go through even if you have a negative balance. It is not an ideal solution since bank overdraft fees can be expensive but may be better than payday loans.
4. Credit Card Cash Back
If you want immediate cash and if your credit card has enough limit, you can use it as a regular debit card. Keep in mind that cash advances usually have a slightly higher interest rates and that interest starts accumulating from the day you take the cash. Even then it might be cheaper than payday lenders.
5. Installment Loan
Most alternative lenders (like Finjoy) offer installment loans starting at $1,000. Since the repayment term is longer and rates are much lower than a payday loan, the monthly payments are smaller and manageable.
6. Payroll Advance
Employees can ask for an advanced payment of their salary before payday. You can talk to your payroll department for options.
Here is a sample repayment plan for the various alternatives in comparison to a payday loan.
| Amount | Term | Repayment | Interest rate | |
|---|---|---|---|---|
| Payday Loan | $300 | 14 days | $345 | 391% |
| Credit Card Cash Advance | $300 | 14 days | $312* | 10% |
| Installment Loan | $1,000 | 9 months | $129 monthly | 44% |
| Bank Overdraft | $300 | 14 days | $307** | 20% |
*$10 fees + 10% interest; ** $5 fees plus 20% interest
Due to their high interest rates, payday lenders need to be licensed and there are different provincial regulations for such lenders regarding interest rates, maximum fees, repayment terms and collection efforts. Here is where you can find that information for – AB, BC, and ON.
If you do find yourself entangled in a payday loan debt cycle, look into a debt consolidation loan. A debt consolidation loan can combine all your payday loans into one by repaying them on your behalf. In turn, you just have one loan to repay on a monthly basis.
Finjoy Capital is not a financial advisory firm.
This article is for informational purposes only and is not a substitute for individualized professional advice.
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