Payday Loans are the Worst!

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If you didn’t know, payday loans are the worst! The amount of interest you’ll end up paying is insane – think 500%+. Yes, you read that right, you could end up paying FIVE HUNDRED percent interest. That makes your credit card interest look like a steal.

With the cost of a loan being so much, why do people even bother with them at all? Well, there might be an unexpected expense or a loss of income where you need a quick fix. But it appears that many people don’t realize how much it’s costing them.

Payday loans have become such an issue that the Financial Consumer Agency of Canada (FCAC) released a report highlighting the need to increase consumer awareness about the high cost of these loans.

Payday loans are the worst

How payday loans work

On average a $100 loan will cost you $21 in fees, so a $300 loan will cost you $63. At face value, that’s a 21% interest rate which appears to be lower than some credit cards. However, credit cards (and lines of credit) charge based on an annual percentage rate (APR). Payday loans will require you to pay back your loan in the next 14 days (your next payday, hence the name), which is much more expensive.

The real cost of borrowing that money for 14 days ends up being 547.50%!

How did that number get so high? Here’s how payday loans are calculated. Take the cost to borrow ($63) and divide that by the amount borrowed ($300). This will give you the interest rate for the duration of the loan which works out to 21% for 14-days.

To get the annual rate, you need to first figure out how many two week periods fit into a year. For the exact amount, divide 365 (days) by 14 (days); that gives you 26.0714.

Finally, take the two week period (26.0714) and multiple it by the interest rate of two weeks (21%). That’s an annual interest rate of 547.50%!!!

Still confused? My friend Preet Banerjee explains why payday loans are the worst in this video

Facts about the payday loan report

The goal of the report was to figure out why people use payday loans. The findings were quite alarming

  • 43% were aware that payday loans are more expensive than credit card cash advances
  • 89% said they used a payday loan to cover unexpected expenses, necessary and expected expenses, and to avoid late charges on bills
  • 20% had a reported household income exceeding $80,000, while 7% had more than $120,000
  • 65% said they did not have a credit card when they last used a payday loan, while 88%  said they did not have a line of credit

Without analyzing the data too much, it seems like quite a few people just don’t understand how much these payday loans cost. It’s really not surprising, payday lenders have flash advertising which makes the loans seem free. Unfortunately, you have picked up much more debt before you realize what you really owe.

Having access to credit can be a real issue too. Without knowing the details, I imagine some people who use payday loans are desperate. The good thing is, there are options.

How to avoid payday loans

The most logical thing would be to build an emergency fund. As the name applies, this fund is meant to help you through any emergencies. I personally set aside three months’ worth of expenses which I can easily access. For some people, three months of expenses is a lot of money so start by putting aside $25 – $50 a month.

Another good option and what some people use as their emergency fund is a line of credit. A line of credit is available from your bank, but you’ll need a good credit score. They’re attractive since they have reasonable interest rates and are pretty easy access. Of course, if you’ve got a questionable credit history, it’s unlikely your bank will approve you.

Finally, there is credit card cash advances. They’re incredibly expensive since they average 20%+, but that’s a lot cheaper than the 500%+ from payday loans. The only time you should use a credit card cash advance is when you’re only other option is a payday loan.

Final thoughts

There are many lenders out there with flashy advertising and promotions that lure you in, but you could end up paying a fortune. Whenever you borrow money, be sure to read the fine print. If you haven’t figured it out yet, payday loans are the worst. Don’t get one!

About Barry Choi

Barry Choi is a Toronto-based personal finance and travel expert who frequently makes media appearances. His blog Money We Have is one of Canada’s most trusted sources when it comes to money and travel. You can find him on Twitter:@barrychoi

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