Understanding the True Cost of Payday Loans and Cash Advances

Anyone strolling down Robson Street in downtown Vancouver may disregard this type of sale advertisement unless you happen to be a financial planner or desperate for a cash advance.   As a financial planner, I took note of this particular signage because my plans were to address this in a blog post.   But I also remembered the first time I applied for credit. I made an application for a Sears credit card and was declined.   I felt devastated and ashamed yet I trusted that the company’s reasoning must have been valid. The reason for the decline could have been missing or inadequate information and even lack of credit history.  I didn’t understand and I didn’t ask. Now I will never know.

When people are refused credit, they become desperate in times of distress.  Payday Loans and Cash Advance stores are frequently being used by people who find themselves in these types of situations. They may not fully understand the fees and true cost of borrowing from these venues.  At first glance these may sound like great deals but really aren’t.     

Calculating the Cost of Borrowing

The Financial Consumer Agency of Canada (FCAC) provides a clear illustration of the cost involved with payday loan compared to other ways of borrowing.  Undoubtedly, you can see the price difference you pay when you borrow $300 for 14 days.  This information should convince anyone from using cash stores. It’s all in the math. 



Financial Consumer Agency of Canada


The costs shown in this example are for illustration purposes only. Calculations of costs are based on the following assumptions:

• a payday loan costs $21 per $100
• a line of credit includes a $5 administration fee plus 7% annual interest on the borrowed amount
• overdraft protection includes a $5 fee plus 19% annual interest on the borrowed amount
• a cash advance on a credit card includes a $5 fee plus 21% annual interest on the borrowed amount.

 

The Good, the Bad and the Ugly

One cannot dispute the “good” about the payday loans.  They are convenient, providing quick access to money within the hour. The advertisements proclaim “no credit check”. These are probably the only visible “good” things about payday loans.

Behind the good is also the “bad”. Some people find themselves growing dependent on regular advances every payday.  When a part of a paycheque is used to pay off your debt, a person will find themselves short of money for other expenses.  Once again, they will be forced to apply for another advance. The endless cycle begins and develops into larger advances.  The associated cost takes more from their paycheque than just repaying the borrowed principal.

The “ugly” is the fees deemed to be reasonable by the Canadian Payday Loan Association (CPLA).  The cash stores make no mention of an annual interest rate since they only charge a fee for their service.  When these fees are translated into an annual interest rate, they’re ugly.   The law requires the cost of credit to be disclosed by defining the APR (Annual Percentage Rate), the rate of interest charged on a loan each year.  At the Money Mart® website, the fine print states for Saskatchewan residents, the APR on a $300.00 loan for 14 days is 599.64% on a rate of $23.00 per $100.00 borrowed.  This calculated annual interest rate of 599.64% is not a typing error.  That’s enough to blow anyone’s mind.  The cautionary message can’t be any clearer than this “Payday Loans are High Cost Loans.”   

Breaking the Cycle 

People depend on these types of loans because they may have been misled into believing their credit is poor.  Although their credit is below the standard requirement, they may not have any direction how to fix their credit score.  Any effort to improve a credit score in order to apply for a Line of Credit or Overdraft Protection at a bank or credit union will save money when borrowing is necessary.

People have also felt intimidated by financial institutions because of what others have told them or even from their past experiences. Their fears may be unwarranted.  Finding the courage to develop a relationship with someone at a bank or credit union where they feel comfortable will diminish their fears. 

In his book, The Success Principles, Jack Canfield emphasizes taking 100% responsibility for your life.

Don’t be afraid to ask. Most people are afraid to ask for feedback about how they are doing because they are afraid of what they are going to hear.  There is nothing to be afraid of.  The truth is the truth.  You are better off knowing the truth than not knowing it.  And once you know, you can do something about it.

Fixing the Problem

The only way to wean oneself from using payday loans may be to find some way to earn extra cash.  The purpose is to simply get ahead.  If that means working an extra job for a short period of time, then do it.  If it means borrowing money from friends and family with full intentions of paying them back, then do it.  Doing nothing other than paying more money in fees than you borrowed does not make financial sense. Two other solutions also come to mind. First, learn how to prepare for an emergency. Second, apply the teaching by Bob Proctor who instills the message, You Were Born Rich.  The answer might not be so simple but you must do something so that cash stores will not be the solution to put food on the table.