More Canadians are turning to payday lenders and many people don’t understand the costs of this form of credit, according to a new report by the Financial Consumer Agency of Canada.
The agency calculated that 1.9 per cent of Canadians had used payday loans in 2009, and that number more than doubled to 4.3 per cent in 2014.
“We are a bit concerned about the number of people using these,” said Jane Rooney, financial literacy leader for the Financial Consumer Agency of Canada. That’s part of the reason why the agency surveyed 1,500 payday loan users, looking at why they took out their loans.
“What the survey findings showed is that people really don’t know the cost of these compared to a cash advance on a credit card, a line of credit or overdraft protection,” she said. Only 43 per cent of respondents correctly said that payday loans were more expensive than these other options.
For a $300, 14-day payday loan, consumers can expect to pay an additional $63 in costs, according to the agency. That’s much more than a cash advance on a credit card for the same amount ($7.42 in additional charges), overdraft protection on a bank account ($7.19) or borrowing from a line of credit ($5.81).
“If people really understood payday loans, they would say, ‘Why would I take out a loan that has the equivalent interest rate of 500-600 per cent?’ That’s crazy. They wouldn’t do it,” said Scott Hannah, president and CEO of the Credit Counselling Society, a non-profit credit counselling agency.
But many of the people who take out payday loans say that they don’t have access to cheaper alternatives. Twenty-seven per cent of respondents said that a bank or credit union wouldn’t lend them money, and 15 per cent said they didn’t have time to arrange a loan from a bank. Only 35 per cent said they had access to a credit card.
“It’s tough for a lot of people if they’ve had a hiccup,” said Hannah. “Perhaps they’re unemployed or they have an injury and their income took a hit. Perhaps they fell behind on conventional credit. Unfortunately it’s going to remain on their credit report for a number of years, which makes it difficult for an individual to qualify for that form of credit until their credit rating improves.”
These people, particularly lower-income people, don’t have savings to draw on in the case of an emergency, and can’t access conventional credit, said Hannah. He thinks this is a gap in the market.
“There really isn’t access to a lower rate small loan.”
And most of the loans are small – according to the survey, 55 per cent of loans were for less than $500. They were mostly used for unavoidable, unexpected expenses.
“I think our financial institutions have the resources to assist some of these individuals without taking on too much risk,” said Hannah.
Paying it back
Rooney would like to see people prepare in advance for financial emergencies, like a car breaking down, so that they don’t need to turn to credit in the first place.
“The average payday loan is $500. If someone is able to set aside even $1.50 a day, that adds up to about $550 over the year so they would actually be able to avoid using that payday loan,” she said.
She also thinks that people need to understand how expensive these loans are.
“We really want people to shop around for and understand better the costs of these products versus alternatives.”
Hannah believes that while there may be some cases where a payday loan makes sense, people need to have a repayment plan when they take one out, or risk falling into continuous debt. “If you were short $300 for this paycheque, what things are going to change that you can manage with $300 less next paycheque? The reality is probably nothing is going to change dramatically. And that’s the trap that people get themselves into.”
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When faced with a financial emergency, he suggests talking to someone you trust before making any decisions. “The first thing is don’t panic,” he said. “If you’re the person who’s got the financial crisis, you’re reacting to it emotionally rather than thinking it with your head.”
There are a number of alternatives to explore before taking out a payday loan, such as asking for an advance on your paycheque, or arranging to defer payment on some bills, he said.
But both Hannah and Rooney believe that financial literacy is key. “We need to do a way better job about educating kids about managing money effectively,” said Hannah.
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Editor’s note: An earlier version of this story stated that 35 per cent of respondents reported not having access to a credit card. In fact, only 35 per cent do have a credit card, according to the report. We regret the error.