Why Avoid Payday Loans

Payday loans do not provide genuine assistance. They cannibalize future income, often for insufficient reason, and involve paying charges that would be illegal if they were defined as interest rates. Promoted in the past as an easy way to get some ready cash for a beer on the restaurant patio in the summer, they have been restricted by recent legislation to make some irresponsible practices more difficult. Overall, however, even in the direst emergencies, payday loans should be avoided.

Payday loans are typically issued by check cashing companies such as MoneyMart. To obtain a payday loan, an applicant must fill out an application. The application requires personal references, but those have been known to be fudged successfully. The applicant must also present three documents: a pay stub, a copy of a bank statement proving that the last paycheck or direct deposit was deposited to the applicant’s checking account, and a paper check drawn on that account that is made out to the applicant and countersigned by her. The usual payday loan amounts are between 30% and 50% of the paycheck. Terms of repayment used to be weekly or biweekly, so that the check had to be dated for seven or fourteen days to the date of issue. It also used to be the case that applicants had to be gainfully employed. Recently, however, payday loan companies have started issuing payday loans to people with monthly pay cycles, and allowing people on fixed incomes, such as pensioners, to obtain payday loans as well. There is no interest charged because the amounts charged would be illegal if they were called interest. Instead, there are “fees” averaging 20% to 25% of the amount of the loan. If someone gets paid $800 a week, she may borrow up to $400 for seven days, but must pay back as much as $500, or $100 more than she borrowed. Once the loan is approved, the debtor is issued cash on the spot. Her check is made out for the repayment amount and may be cashed by the payday loan company or redeemed ahead of time if the debtor brings enough cash at least a day early.

The fundamental problem with payday loans is that they are borrowings against future income, usually by people for whom even their full income is not enough. Most financially responsible and well-off people do not take out payday loans because the service charges amount to as much as 1300% of the loan principal per year. If people need emergency funds, they spend their emergency savings, take out a bank loan or line of credit, mortgage their property, sell valuable possessions such as jewellery, or borrow from personal contacts. Those who make use of payday loans usually fall into two categories: people who have no savings and bad credit, and people who want a loan for purposes, such as casino trips, that are frowned upon by most institutional and personal lenders. These people would not be getting a payday loan if their regular pay were sufficient to meet their needs. By cannibalizing part of their future pay, they put themselves even deeper in the hole when their next pay comes, requiring another payday loan immediately after the last one is repaid. This cycle of so-called “revolving payday loans” has been known to go on for several years, paycheck after paycheck after paycheck. In some cases debtors have taken out simultaneous payday loans at two or more different check cashing companies. The normal outcome of taking out one’s first payday loan is a revolving payday loan cycle and eventual default on the loan, which leads to additional service charges, being hounded by debt collectors, and a permanently destroyed credit rating.

In recent years, some payday loan practices have been restricted by the government. In Canada, federal legislation now prohibits revolving payday loans and simultaneous payday loans issued by multiple lenders. In addition, MoneyMart Canada was recently ordered by the court to forgive all defaulted loan amounts and associated service charges covering a certain period of time. Yet it is easy to get around such restrictions by taking out a payday loan at MoneyMart for this pay period and then at Cash Money for the next pay period before going back to Money Mart again. The charges are still usurious, or would be if they were called interest, and the revolving payday loan still very much happens.

Payday loans provide no assistance at all. Even in the direst emergencies, they create even more problems than the beleaguered borrower already has. For that reason, payday loans should always be avoided by everyone in every situation.