Tough Choices for Surviving Tough Financial Times: Paying-off Debt with More Expensive Debt!

These are unprecedented times indeed. Millions of Canadians have lost their jobs as a result of the ongoing pandemic. Governments at all levels (Federal, Provincial and Municipal) are doing their best to alleviate the financial hardships faced by their citizens. Even financial institutions, like insurance companies and banks, have responded by reducing their rates or deferring repayment requirements.

 

However, informal polling shows that one sector – the Payday Lending sector – continues to survive and thrive upon the financial hardships of Canadians by obfuscating the true cost of their services.

Let’s un-package the complex world of what it costs to borrow from these lenders.

 

THE HIDDEN COSTS OF PAYDAY BORROWING

 

Payday loans are meant to meet short-term cash flow needs. Individuals facing a severe cash crunch, or those who are desperate for funds in times of need, typically turn to payday lenders. So, why don’t these borrowers simply go to their bank and borrow the money they need? Well, the typical Canadian payday loan client:

  • Does not have a steady job, or if he/she does, they don’t have a 5-figure income
  • Borrows up to $1,500 (the maximum allowed under Canadian law)
  • Intends to repay the loan within his/her next payday cycle (typically 15-days), although some provinces allow a maximum of 62 days to settle the debt
  • Usually doesn’t have a stellar credit score or an unblemished credit history

As a result, traditional financial institutions, such as banks and credit unions, won’t lend money to individuals with this profile. Their only recourse, when they need money quickly, is to turn to the corner payday loan shop (in some Canadian cities, there are multiple lenders within a short walk!). And, sensing that desperation in their client base, payday lenders don’t offer “free money”, as many misleading ads like to portray.

 

Unfortunately, in dire financial times, as most economies around the world face today, cash-starved borrowers are turning to payday loans as their primary source of financing. Instead of using the funds for emergencies, such as medical expenses or paying-off high-interest debt, many Canadian borrowers use them for funding their ongoing lifestyle expenses, including rent, groceries, utility bills and other day-to-day expenses.  They do this because, at some levels, they’re bedazzled by the complex math.

 

OBFUSCATION MATH

 

The Annual Percentage Rate (APR) is a standard-bearer for loan affordability across many sectors. For instance, when you apply for a mortgage, put an application for a credit card, or go in to buy a car, lenders and dealers always talk about the APR. However, when it comes to payday loans, most lenders take exception to borrowers’ use of APR as a financial gauge. They’ll typically obfuscate the issue by highlighting the differences as being as stark as buying a home versus paying rent; or like owning a car versus driving a short-term rental.

 

There may be a point to stressing those differences (or parallels!). However, to the average Canadian seeking a desperate cash infusion, the acronyms don’t matter. What matters is how to assess the affordability of their loan. And the best way to gauge that is by understanding the financial math.

 

Let’s assume a hypothetical payday loan (Note: Numbers deliberately chosen to underscore a point!) here with the following characteristics:

 

 

Lenders go to great pains to ask borrowers to “ignore” the almost 600% APR. Instead, they’ll (rightfully) stress that you aren’t borrowing for the entire year. Instead, they’ll make the case that borrowers must focus on the “amazingly low” 1.64% (APR divided by 365 days) daily rate they offer. For the typical borrower, eager to get the money into their bank account to pay their rent, that rate (1.64%) sounds more palatable than the 599.64% APR. It is that obfuscation that usually seals the deal!

 

UNPACKAGING THE NUMBERS

 

To really make sense of these numbers, however, requires doing some more math. Unfortunately, when you’re looking at the promise of receiving funds into your account in 24-hours or less, no one stops to do more math. But they should! Unpackaging the numbers behind the 1.64% offers us a better look at what borrowers are signing up for:

 

 

The “amazing low” 1.64% daily interest rate, for the $375 14-day loan, translates to $6.16 in interest paid daily. Over the 14-day loan term, this borrower will pay $86.25 in interest charges. And THAT translates to a whopping 23% effective rate for the use of $375 over a 14-day period. To put things in perspective, here’s what that 23% translates to per $100 worth of debt:

 

 

Paying $86.25 on a $375 loan ends up costing you $461.25 in total repayments. That works out to a 23% effective rate – although it also amounts to 1.64% daily. However, if someone stressed the 23%, instead of highlighting 1.64%, it’s likely you’d rethink your interest in the loan. However, when you’re desperate, you may consider even 23% a better figure than 599.64%. The truth is that, in an apples-to-apples comparison of affordability, 23% still is a high rate of interest by many standards.

 

DEEPER INTO A FINANCIAL HOLE

 

Most Canadian lenders charge the maximum “finance charge” allowed by law in their jurisdiction. Many jurisdictions cap the maximum fee/interest that payday lenders may charge to $15 per $100 lent. However, not every borrower is able to repay their debt in time. Most payday lenders allay borrower fears about being unable to repay their debt. The typical sales pitch is:

 

“Can’t repay on time? Don’t worry, we’ve got you covered – Simply roll over your loan and pay us on your next pay day cycle!”

 

And there lies the dilemma. Many unaware borrowers receive these assurances as a sign that their payday lender has the borrower’s best interest at heart – by allowing them a chance to defer payment. But the truth is, that by “rolling over” their debt, payday loan borrowers are digging themselves deeper into a financial hole. Here’s how:

 

 

While rollover might seem like a convenient way to defer loan repayment, the consequences – that lenders won’t fully explain to the borrower – can be devastating. A 15% rate, on a 14-day loan, can more than double (to 32.25%) within a period of 30-days. This pushes payday loan debtors deeper into the financial hole they are already in!

So, what options do desperate borrowers have?

 

IRRESISTIBLE TEMPTATIONS

 

Sadly, there are limited avenues for Canadian’s looking for low-cost, small-scale financial assistance when in a crunch. For instance, you may have your account credited with money from a same day etransfer payday loan in Canada within 24-hours or less. And, unlike tier-1 financial institutions, you don’t even have to undergo a credit check or provide guarantors for your loan.

 

This makes payday borrowing a rather irresistible proposition, and that’s what keeps these lenders in business!