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How Payday Loan Schemes Work





Payday loan stores seem to be on every street corner and all over the web these days and with good reason – they are extremely profitable. While corporate profits are a good thing, these payday loan stores market to the clientele that simply do not realize how much they are being ripped off.

How do these payday loan stores work?

From my research, most of these establishments work in this fashion:

  1. Client applies for a loan, provides proof of employment, income and chequing account.  Loan terms are typically on a bi-weekly basis,  thus the name Payday Loan.
  2. Once approved (usually very quick), the cash is deposited directly into the clients chequing account.  Note that most of these establishments allow a maximum of a $1,500 loan.
  3. When the loan is expected to be repaid (usually on payday), the money plus fees and interest are automatically withdrawn from the account.

As you can see, providing that the client is employed, it is very easy to get access to cash through Payday loan stores.  However, that is the end of the good news, the elephant is the room is how much do these Payday loan stores charges in interest/fees.

It turns out that the fees depend on the province of business as most of the provinces have set regulations as to the maximum amount that payday loan stores can charge.

For example,

  • In Ontario, the maximum is $21 per $100 borrowed;
  • In Alberta, the maximum is  $23 per $100 borrowed; and,
  • In Nova Scotia, the maximum is $25 per $100 borrowed.

Say Mr. Nova Scotia needed to pay his cash-only car mechanic, and was short about $500 so he decides to avail of the services of a payday loan store.  While our Maritime friend may get his $500 cash in a relatively short period of time, it will cost him at least $125 for the 14 day loan.  On an annual basis, that is an interest rate of 652%.  Also, not only is there regular interest, but there is the possibility of late charges and/or other processing/setup fees.

While these loans can be convenient, the interest rates are pure robbery and will put the debt ridden into deeper debt.  There are better solutions for emergency cash.  I would typically never recommend this, but if someone is desperate for cash, it’s much cheaper (and easier) to get a cash advance from a 21% interest rate credit card via ATM.  The only situation where I can see any value in a payday loan is if someone had bad credit, didn’t have any cash or credit cards, and required temporary emergency cash.





17 Comments, Comment or Ping

  1. 1. nobleea

    Here in Alberta, I see ‘sale’ signs for payday loan stores all the time. They were touting a $200 cash advance for a fee of ONLY $20. I laughed thinking it was a joke, then realized it wasn’t. And given how many payday loan stores there are here, it’s quite scary.
    One of the cash advance companies is based here in Edmonton (Cash Store Financial, CSF on the TSX), maybe that’s why there’s so many stores.

  2. 2. jbearr33

    I livein a small community of 7,500 people with a lot of good oil jobs, and we have 3 of these types of service centres. A little scary to think there is that much business for them here.

  3. It blows my mind that high income people would even consider using payday loans. I wonder if income statistics relative to payday loan usage is available somewhere..

  4. 4. Toby

    These places are the devil and it should be against the law for them to operate. Charging 20%+ fees is a sin. The government should re-evaluate these laws. There may be a use for the service they provide but it should be at a much more reasonable rate. The people who need these services can not afford to pay the ridiculous fee they charge.

  5. 5. SST

    Hmmm…I wonder why “payday loan” stores are viewed as scheming and ripping off customers, yet the entrenched financial industry which does a far more immense amount of ripping off, is viewed on the up-and-up.

    At least the payday store tells you right up front exactly what is happening: $21 for $100; the financial industry has to hide behind multiple veils of deceit in order to pull off their schemes.

  6. @SST, can you provide examples?

  7. 7. Steve

    Do they have an ETF for these things yet? ;-)

  8. 8. Chris L.

    You feel sorry for someone who would use these “loans.” They aren’t loans though, they are services with service fees. Call it a poor budgeting service for people who can’t wait for things coming to them in 2 weeks. Familiar with the marshmellow challenge? Kids were followed into adulthood. The experimenter presented the kids with a couple marshmellows and said if they could wait, rather than eat them instantly, they would be rewarded with even more marshmellows on return. The kids would could wait the longest turned out to be better in school – they were more willing to delay instant gratification in lieu of a greater reward. Payday loans are for the kids who quickly gobbled up a few marshmellows because they couldn’t wait. This isn’t a sad story and the government doesn’t need to “help” them or govern over them. Who says a quick fix is bad? While you toil and wait, these payday loands provide instant gratification to people who need satisfaction right now. Their fun is happening right now…right now, you toil. You can say one way is better than another? How?

  9. 9. Emilio

    Agreed with Chris. If everybody in this world was responsible, there would be no need for payday loans, but the world would be a very very dull place.

    For instance there would be no raw material for daytime tv, such as Jerry Springer, Maury Pauvich, etc… There would be no raw material for shows like Cops, America’s most wanted. There would be no need for welfare, and our taxes would be a lot lower…

    But the fact of the matter is that human beings are very diverse, and a great part of them, rely on this instant gratification, and even previous gratification, as in spending something they don’t have….

    Watch out as when the apocalypse comes, the people that use payday loans will be the first ones to break into your homes and stab you over a piece of stale bread and two cans of tuna… :-D

  10. 10. Timmyson

    I narrowly avoided a suspension in elementary school for attempting to charge similar interest rates.

  11. 11. Mark

    How is this not an example of usury (making loans with abusive interest rates)?

    In Canada it is supposed to be illegal to enter into agreements that charge an annual rate in excess of 60%:
    http://laws-lois.justice.gc.ca/eng/acts/C-46/page-163.html

    I don’t understand how these businesses are able to stay open.

  12. 12. Chris L.

    Mark, these are not loans. These are a cash advances with service fees. Service fees that people happily pay for.

    You’re more than welcome to stand nearby cash advance establishments and bridge people’s finances yourself. Post an ad on kijiji! You can help out as many people as you want. Capitalism will provide you with a wonderful niche to provide reasonable loans at reasonable rates. I’d recommend you don’t however.

    There’s a reason there are 3-10 cashback franchises in each city. People want them.

  13. 13. SST

    @FT: “SST, can you provide examples?”

    Of financial industry scheming and rip-offs?

    Seriously?

    1. Let’s start with the biggest case of financial fraud in the history of mankind — LIBOR fixing. You can read all about it, everywhere. The banks involved have stated the lawsuits against them will be null and void because it’s impossible to calculate the amount of money stolen.

    2a. Or perhaps the debacle in the past year of MF Global and PFG.
    Both companies sat on the NFA committee which devise the rules for their industry at large (in conjunction with the CFTC and
    They were making the rules yet at the same time stealing outright from their customers for years and decades.

    2b. What’s even more awesome are the companies which sit on the swap dealer committee — JP Morgan, Bank of America, Deutsche Bank, USB, Citigroup — ALL involved in criminal activity #1.
    That’s 50% of the people making rules conducting illegal business.

    3. Or how about the ‘Million Dollars to Retire’ marketing scheme that is still being pushed, as in this very recent article:
    http://www.theprovince.com/business/Making+magical+million+mark/6939157/story.html

    The author works for the National Bank of Canada.

    Perhaps someone should enlighten both employee and employer of the FACT that ~1% of Canadians currently have a net worth of $1 million or more (sans principle residence). At the height of Boomer retirement, that number will swell to a staggering 2%. After the Boomers die off, if the trend continues, millionaire population will be back down to 1%.

    He states “all of my clients are millionaires”; perhaps he is severely sheltered and has no clue of the greater society around him.
    Or maybe he does: “But the good news is there are an awful lot of happy people around who don’t have $1 million and never will.”

    (I wonder how many of his clients he personally has made millionaires via his portfolio management, or if they were already millionaires when he got hired?)

    Let’s be realistic, 99% of “happy people” will never have $1 million worth of anything.

    Why would a financial planner — and the parent bank — push the million dollar dream they know is extremely unachievable unless it was to support their own income?
    “Give us your money, we’ll make you a million bucks…for a fee! (*but we aren’t liable if we loose it all)”

    Scheme, rip-off, or ethical behaviour?

    Payday loan stores are no more a rip-off to the consumer than every single 7-11 convenience store.
    How can they charge me for $6 for a thing of milk when I can buy quadruple the amount at Costco for only $3!

  14. 14. SST

    Yet another example of an A1 rip-off just popped into my head, albeit from a non-financial institute company, B.C. Hydro.

    For years they have marketed their hydro power as being some of the least expensive available in North America. So “the clientele that simply do not realize how much they are being ripped off” buys in and uses their electricity.

    What they didn’t tell us was that for years the executives were cooking the books (all legally of course, but far from ethical), pushing their debt forward and proclaiming a profit in order to secure their yearly bonuses.

    That bubble burst and now each and every customer is on the hook for their $2+ billion (and rising) of debt, as well as raising their rates 17% over the next three years (good thing inflation is only 1.2%!).

    Payday “loans” might severely stick the customer over a short period, but the quasi-legal activities of B.C. Hydro will bleed the tax payers for at least a decade.

    Hope the execs are enjoying their money.

  15. @FrugalTrader

    We have a municipality in Victoria (made of 13 little cities) that is trying to avoid having another Cash Advanced type business in its main square (it is closest to the navy base).

    I dislike the fees that they charge but these stores have a purpose and provide a service that consumers are willing to pay.

  16. 16. Goldberg

    I agree with Steve. There’s a market and they clearly show their fees. The proposition is clear. Most will pass, the few that don’t, do so willingly.

    Government should not be in the business of preventing enterprise.

    How about greater transparency in GM foods or Red Bull being a drug served in the form of a drink…

  17. Good post! As professionals who help Canadian eliminate their debts so they may achieve their goals sooner, we have seen Canadians from across the country get caught up in the vicious web of pay day loans -some with as many as 5 all coming due the same pay day for a total of more than they earn in pay!!

    The Toronto Star did a major investigation on payday loan lenders a few years ago that you may find to be very interesting.
    http://www.thestar.com/News/article/279325

    Cheers,
    Eric Putnam,
    Managing Director, Debt Coach Canada

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