August 21, 2023

How to avoid the perils of payday loans

Do a quick online search for why you should avoid payday loans and you will find countless warnings about why you should never resort to taking out a payday loan.

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5 ways to avoid the perils of payday loans

A person holds money they got from a payday loan

A quick search online about payday loans will bring up countless warnings about why you should never resort to taking out a payday loan. But despite all the warnings, many Canadians are relying on payday loans each year.

The Canadian government announced in the 2023 budget that it would pass legislation to lower the maximum allowable annual percentage rate (APR) on loans to 35%, something poverty activists have cheered, and matching legislation already in place in the province of Quebec. This doesn’t mean that payday loans will become risk free though, or that they are a good solution to money troubles.

These loans will still have higher interest rates than most types of borrowing and can easily cause people to fall into a debt trap. So, what are better options than resorting to a payday loan when your short on money?

What are payday loans and how do they work?  

In theory, a payday loan provides fast cash and a seemingly quick fix for a shortfall in income. These are short-term loans which are often meant to be repaid within a couple of weeks. 

These loans come with very high fees though, which can be confusing to understand. It’s no wonder that many people struggle to afford to pay back the loan once the bill comes due.

The cost of borrowing from a payday loan varies from province to province. , At the time of writing, the cost of borrowing is capped at a maximum of between $14 to $17 per $100 borrowed, A cost of $14 per every $100 translates to an APR of 391%, while $17 per every $100 is an APR of 442% the Financial Consumer Agency of Canada notes. (APR is used to calculate the yearly cost of interest and any additional fees or costs associated with a loan that is charged to borrowers.)

The government is proposing to lower this across the country to $14 for every $100 borrowed, currently Newfoundland and Labrador is the only province with the $14 cap. 

But how does that meet the standards for the proposed 35% cap?   

As we said, payday loan fees are tricky. Lowering the APR to 35% while still allowing places to charge $14 for every $100 borrowed seems contradictory after all.

In the case of payday loans, the $14 fee charged for every $100 borrowed is a fixed portion of the loan amount.

The APR, on the other hand, is an annualized percentage that reflects the cost of borrowing over a year, including both the interest rate and any additional fees.

As payday loans are short-term, often due in just a couple of weeks, they have high APRs. Meaning it costs much more to pay back over time that other forms of lending in the long-term.

Essentially the $14 for every $100 borrowed is a cap on the fees that payday lenders can charge borrowers, while the proposal to limit the APR on payday loans to a maximum of 35% is a cap on the total cost of borrowing, including interest and fees on an annual basis. 

The Quebec exception

In Quebec payday loan options are much more limited than the rest of the country. There, the province has strict consumer protection laws. One of these is that payday loans cannot exceed an APR of 35%. The government is hoping to make this the norm across the country.

What are alternatives to payday loans?

What we’ve talked about so far here is not actually law yet. As it currently stands, payday loans are allowed to charge very high interest rates and are by no means a safe bet to help someone financially. Payday loans will still be a high risk even if the proposed changes are enacted before the next federal election.

It’s not uncommon for someone who has failed to pay back their first payday loan to take out a new payday loan to try and pay off the first loan.

Payday loans seem like an attractive option to many though because they do not require you to have good credit. You just need to provide a paystub proving you’re employed.

If you have bad credit options four and five listed below are both better alternatives to a payday loan and also don’t require you to have good credit.

If you’re struggling financially there are always better options out there to help you. 

Are you looking to explore your debt relief options?

1. Get overdraft protection from your bank

This is a much more cost-effective way to afford things than a payday loan. You can apply for overdraft protection through most banks in Canada. 

If you’ve never heard of overdraft protection here’s how it works. Once you complete the application with your bank, the bank will cover transactions that exceed the amount of money in your account. If you only had $20 in your account and bought something that cost $25, the bank would cover that extra $5 for you.

Overdraft protection varies from bank to bank. The minimum overdraft protection limit is typically between $100 to $250, depending on what bank you’re with.

The maximum overdraft protection limit is usually about $5,000.

The bank will charge you a fee for covering the transaction and you will also be responsible for paying the bank the amount it covered for you, plus interest.

You can pay for overdraft protection a variety of ways, according to the Financial Consumer Agency of Canada. Here’s two of the most common ones:

  • Basic protection: Your bank sets a limit of the amount it will cover you for. You also pay interest on the overdrawn amount along with a fee each time you go into overdraft.  
  • Monthly: You can pay for overdraft protection on a monthly basis. This costs only about $5 a month.  This means you aren’t charged a pay-per-use fee each time you go into overdraft. Some banks also waive the $5 fee for months you don’t go into overdraft.

2. A personal loan

Personal loans are another great alternative to payday loans and are offered through most banks.

One of the major advantages of a personal loans is they allow you to spread your repayment over a much longer length of time. Payday loans are due very quickly and in full, while a personal loan allows you to make regular payments monthly for a set period of time. You know exactly how much you owe each month and you know exactly when the debt will be fully repaid.

Personal loans, when offered through your bank, also have much lower interest rates than payday loans. Be wary of installment loans that are offered from the same companies as payday loans, as they will charge very high interest rates.

3. A line of credit

A line of credit is another great alternative to taking out a payday loan. A line of credit is offered by most banks and lets you access up to a predetermined amount of money that they agree upon with you.

You have many more repayment options than you would with a payday loan. You can choose to make minimum payments, make larger monthly payments until the debt is gone, or choose to pay off the balance in full. This flexibility allows you to manage repayment according to your budget and avoid falling into a cycle of debt.

4. Ask family or friends for money

We know that talking about money and financial issues with people you know can be challenging. It’s seen as a taboo subject for many. 

If you’re short of money and the amount isn’t too high, people in your life are often willing to help you out. If you need $200 on a short-term basis it’s likely that someone who knows and trusts you to pay them back will be more than happy to loan you the money. Friends and family often won’t charge you any interest at all if you show you can pay back the money by a certain date.

5. Explore debt solutions with a Licensed Insolvency Trustee

Sometimes financial troubles are too big to be solved in a DIY manner.  If you’ve tried one or more of the options above, or don’t think that these will work for you, and you’re still struggling it may be worth scheduling a free consultation with a Licensed Insolvency Trustee to learn about all the other options that are available.

BDO Licensed Insolvency Trustees are regulated by the federal government of Canada and are ethically bound to only act in your best interest. They can help you find a rage of debt relief options, including a consumer proposal, which reduces how much you owe by up to 80% and lowers your minimum payments dramatically.

There are always options to help you become debt free and the first consultation with any of BDO’s Licensed Insolvency Trustees is free.

Do you have more questions?

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August 21, 2023

How to avoid the perils of payday loans

Do a quick online search for why you should avoid payday loans and you will find countless warnings about why you should never resort to taking out a payday loan.

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