What is a Pay Day Loan?
Pay day loans are short term unsecured loans for unexpected cash needs. Usually the loans are intended to be paid back within 2 weeks or by the next pay date. They should be used to cover very occasional emergencies and not for making up the shortfall in monthly budgets.
In order to qualify for a loan the borrower must provide identification, have a chequing account and proof of a regular income. The borrower must provide a post dated cheque or preauthorized payment form to cover the loan plus interest plus charges.
The pay day loan companies in Canada are regulated by the Canadian Pay Day Loan Association (a self regulatory organization) which has produced a code of best business practices.
This code stipulates standards and guidelines for:
- Loan interest rates
- Borrowing limits
- Collection practices
- Roll over and multiple loans
- Education and awareness
The pay day loan industry has experienced exponential growth over the past 20 years and in recent years has come under the scrutiny by the Financial Consumer Agency of Canada (FCAC) the consumer watch dog of the federal government. The pay day loan industry has faced scrutiny with regards to its business practices and rates of interest charged to consumers on their these short term loans. In Canada the Criminal Code makes it a criminal offence to charge higher than 60% interest per annum.
What consumers don’t realize is that the average interest rate when these pay day loans are rolled over for a year range from 400% up to and in some cases can exceed 1000%!
So how can they get away with charging so much you ask? Although the interest rate may remain below the 60% the pay day loan companies are able to charge other non-interest fees that when added into the cost of borrowing means the pay day loans effective interest becomes exuberant.
The major concern with pay day loans is of course the interest rates and associated fees which are referred to above.
People using pay day loans are often under immense financial stress and need the money immediately. They may not even consider the costs of borrowing given their predicament and their focus is on the immediate solution. Unfortunately the solution is often only a temporary one and the loan will remain unpaid by the due date, high interest and penalties are charged, and the borrower is left owing even more money. Less scrupulous lenders also offer to extend existing loans for a fee or offer new loans to pay off the existing leaving the borrower worse off financially.
In fact, this is the pay day loan trap. The original pay day loan is rewritten over and over again as people struggle to overcome their financial crisis. As the pay day loans are rolled over the interest and pay day loan fees mount. The use of pay day loans follows the same pattern as people who get addicted to drugs.
The problem for the borrower is then compounded by the reporting of the unpaid loans to their credit bureau which harms their credit and increases their reliance on higher risk, higher interest loans.
This is a downward spiral which will create a major financial crisis for the borrower.
Defences and Remedies
The best defense against predatory lenders is to have strong financial literacy skills, be your own bank, and to create an emergency fund. By implementing a strict budgeting plan spare cash can be found monthly and directly deposited to an emergency account for these events which you know are going to happen. It’s not a matter of an “if” you might need an emergency fund but a “when”.
The goal is to have the emergency fund reach the equivalent of at least one month`s salary. One ploy to quickly build up this reserve fund is to aggressively cut down all your costs for a period of say 6 months. This quickly frees up the required additional cash before it is needed. Afterwards a more moderate and sustainable budgeting measure can be developed.
But what if you are already caught up in the downward spiral of pay day loans? Get Help.
The best solution may be to file a consumer proposal or even a bankruptcy depending on your circumstances. Before considering such action it is important that you seek the advice of a reputable consultant such as 4 Pillars to ensure you are fully informed.
If you have any questions or concerns and you live in Burnaby, BC please reach out to Gurinder Dhaliwal.
About the Author
Gurinder Dhaliwal operates the 4 Pillars Consulting Burnaby BC office in helping consumers deal with overwhelming money problems through our debt restructuring plans that all include comprehensive credit rebuilding.
Direct Tel: 778 340 4002