Every now and again, we all find ourselves in a financial pinch. When you are strapped for cash, it can be tempting to turn to payday loans. These loans are known for not being too picky about poor credit, and you can get the cash fast. If you’re not careful, though, you could find yourself in big trouble down the road. I was recently on Gail Vaz-Oxlade’s radio show to talk about payday loans, and while I’ve written about them here previously, I wanted to share some more reasons I have a problem with payday loans.
Short Term, High Interest Loans
Payday loans are short term loans made by companies like Money Mart and The Cash Store at very high interest rates. These loans are meant to just get you through until payday, hence the name. Few people, when getting payday loans expect them to last very long, especially since they often mean to immediately pay off what is owed once payday arrives.
Here’s how it works: A borrower writes a personal cheque for the loan amount, plus a fee, payable to the lender. The lender holds the cheque until the borrower’s next payday and then deposits it in the bank if the borrower hasn’t paid by cash before that date. If there are insufficient funds in the borrower’s account, they will owe a return fee to the payday lender and an NSF fee to their bank. The borrower might then take out another payday loan to pay off the original loan.
There are also often chances to renew the loan. If you are willing to come in and pay another fee, the company often agrees to hold the cheque for another pay period. As you can see, unless you change your money habits, this short term loan becomes a long term loan. In some cases, you can renew almost indefinitely. The payday loan company makes a great deal of money as you pay a fee every couple of weeks to extend your loan.
Not only can a payday loan turn into long term debt, but the interest you pay is astronomical. The fees for payday loans are between $51 to $72 on a $300 loan. This works out to an APR (annual percentage rate) of 443% to 626%. As you can see, your short term loan comes with a high cost.
Payday Loan Companies Cash In
What makes me most concerned about these companies is that as financial concerns continue and banks restrict their lending, the payday loan companies I mentioned above both had double digit revenue increases this past quarter over the previous year. These revenues are made from the increasing number of people that believe they have no other options for paying their bills and rent.
It’s clear that payday loan companies serve a need. Consumers who can’t access lower cost options are forced to turn to payday loan companies. As they continue to struggle, the situation only worsens. Unfortunately, many payday lenders take advantage of these situations. They know that their customers have no place else to go, so they basically engage in gouging behaviour, charging extra for this service.
While some might argue that payday loan companies have to charge high rates in order to cover their risk of default, there are those that think that some of the rates and fees are excessive. You could charge a higher interest rate and offset some of the default risk without making it obscene.
Those who can’t afford their payday loan payments can find their credit damaged. In fact, it might be a little damaged anyway, since credit scoring algorithms consider the source of the debt, as well as whether or not you pay. A payday loan isn’t scored as highly as a loan from a reputable lender for something like a car. If you habitually get payday loans, your credit might suffer.
What To Do Instead of Getting a Payday Loan
If you find yourself facing a financial dilemma, it’s important to avoid getting a payday loan if at all possible. Instead, turn to friends and family, and find out if there are community programs that can help you. You can also try a bank loan, or even using a low interest rate credit card, almost any loan is better than getting a payday loan.
Only get a payday loan if you are sure that you have no other choice… and even then think twice.