Payday Loans and Cash Advances

Darren Pries-Klassen & Edwin Friesen

The demand for immediate cash and short term loans is so profound that in a decade the payday loan industry has grown from 0 to 1,400 outlets in Canada and continues to expand. The names on the store front may vary but the services are virtually the same: provide small, short term loans, cheque cashing, and cash advances from a non-traditional lender for a fee.

A 2006 public interest article produced by the Parliamentary Information and Research Service (PIRS) explained the details of an actual short term loan. $400.00 was borrowed at a cost of $51.28 plus the original amount loaned. That is a nominal interest rate of 12.82% and while that might sound reasonable the problem is the "effective interest” rate. (Nominal interest is the rate charged during a compounding period. Effective interest is the amount you actually pay by equating the loan to an annual amount.) In this case the loan was for only 17 days. The effective interest rate balloons to 1,242% when the payday loan is calculated based on 365 days.

Section 347 of the Criminal Code of Canada makes it a criminal offence to charge more than a 60% effective interest rate. Interest rates beyond this amount are illegal and referred to as predatory lending.

So, how is an interest rate of more than a thousand percent possible? Unlike banking and investing, the payday loan business is relatively unregulated. The Canadian Payday Loan Association (CPLA) does have a code of conduct but is a self-regulatory body and membership is voluntary. By using the term "fee” in place of "interest”, payday loan companies have made prosecution under the criminal code more difficult. Consumers seem to be okay with the high cost of borrowing money when it is called a fee, not interest. The cost of borrowing the $400.00 loan was promoted by the payday loan company as follows: Interest = $8.64; Per Item fee = $9.99; Cheque cashing fee = $32.65; Principal = $400: Total cost = $451.28.

The type of person who uses a payday loan service is not necessarily the person you might expect. In a 2005 study by the Financial Consumer Agency of Canada more than half of the respondents cited convenience as the number one reason for using these services while only 14% cited credit and banking issues. What that means is that a large number of people are using this type of expensive credit even thought cheaper options are available to them. Either they don’t know or they don’t care about the high cost payday loan companies charge for their services.

It is understandable that payday loan companies have found a niche market but that doesn’t mean you need to be part of it. If you use or are tempted to use payday loan services, have a look at alternative lenders such as your bank or credit union first. Even a cash advance on a credit card will be less costly than most payday loans. Practice restraint. Is your need for immediate cash going to be used to satisfy a need or a want? If it is a want, you are better to do without it than incur heavy borrowing costs. If you have any doubts about your ability to manage money or make financial decisions, talk to someone who can help you. Contact a financial planner, your bank or credit union, or MFC.

The wisdom of Psalm 22: 7, "the borrower is slave to the lender” couldn’t be more appropriate in the case of payday loan services. Wise management, fiscal restraint, and practicing contentment are as much a part of biblical stewardship as is learning generosity.