The truth about payday loans
By Jasmine Miller • Bankrate.com

Payday loan companies are getting a lot of free advertising these days, but not the good kind: Numerous class-action lawsuits have been launched against the major players in this growing, unregulated industry. The increasingly ubiquitous Money Mart is only one familiar company that is defending itself in cases launched on behalf of customers in almost every province.

The charge: interest rates and fees that, when combined, amount to more than the legal limit of 60 percent a year. The plaintiffs, former payday loan customers, say that the fees tacked on top of the principal loan amount should be included in the legal definition of interest.

The defendants -- Cash Money Cheque Cashing Inc. and Unicash Franchising Inc., along with Money Mart and others -- say those charges should not be considered interest. If the plaintiffs win, Money Mart, et al, will be guilty of charging usury rates of interest and may have to compensate their clients.

A decision is years away. But in the meantime, thousands of Canadians will take out these expensive, short-term loans. The number of these businesses, often located in poorer neighbourhoods, has ballooned to about 1,200 today, creating a huge fringe banking industry. In the past year, an estimated one million Canadians turned to these companies for quick cash.

Deliberately cloaked in complicated language, the contracts and documents customers sign to get a payday loan are often unclear and confusing. "I don't have any use for them, I have yet to see the advantage," says John Eisner, president of Credit Counselling Services of Atlantic Canada in Saint John, N.B.

"To me, anyone that lends money at 60 percent, even though that amount is legal, [is] loan sharking."

The bottom line: You should avoid these loans. If you can't, here's what you need to know about them.

How they work
Payday loans are only for people who are gainfully employed and can prove they have steady pay cheques. "People ask for a certain amount, usually in the neighbourhood of $100 to $500 for two weeks to a month," explains Fran Smith, executive director of the Credit Counselling Service of Alberta, in Edmonton. "The plan is to tide you over till you get paid. Then you go in and pay off the loan."

You provide reams of personal information to the lender. Besides your name and contact information, as well as the name and address of your employer, don't be surprised if they ask for your Social Insurance Number, the names and phone numbers of family and friends or other references and possibly your landlord.

They may also ask for bank statements and particulars of other loans and debts. The approval process is short; often borrowers have cash in hand in less than half an hour.

Many companies offer their services online as well. The process is the same, but you will probably have to fax supporting documents to the lender. The funds are deposited into your bank account.

Being able to afford the debt isn't usually the issue: Customers have been able to get a new payday loan even after disclosing that they have outstanding loans at similar businesses and, therefore, are not likely to pay the debt with their next pay cheque.

For example, you take out a loan of $100. You give the lender a post-dated cheque for that amount plus a processing fee, usually in the neighbourhood of $15. The cheque is usually dated for one, two or four weeks later.

On that date, you have a couple of choices: Let the loan company cash the cheque or roll over the debt. "Roll-over means you take the loan out for another two weeks for additional charges," explains Smith. You pay only the processing fee and the interest accrued up to that point. You have until your next payday to clear the $100 principal.

You can also pay off the original loan and then take out a new loan. "We often see people go to another payday loan company and take out a loan to pay off the first." If you don't pay the loan off when it comes due, this is where the trouble starts.

"It becomes an ongoing cycle of borrowing money. You end up robbing Peter to pay Paul," says Eisner. "The people who are coming through our doors have four or five different payday loans, they start with one and then move to another company. I'd like to know who these companies are refusing."

Remember that this industry is unregulated. There are very few complaints lodged against them through the Better Business Bureau and other consumer protection agencies, a fact that the industry's self-regulating group, the Canadian Association of Community Financial Service Providers, is proud to point out. A spokesman for the CACFSP was not available for comment.

But you shouldn't take that silence as a product endorsement: people may be too embarrassed to come forward. "These companies would probably say, 'We are meeting all kinds of people's needs,' and that's probably true," says Eisner, "but at what cost?"

That's why Smith says you have to be diligent if you take a payday loan. "You have to ask, 'What am I going to have to pay, what are the fees?' I've heard of administration fees being $100 on a $300 loan," he says.

Why they are a bad idea
"In most cases, people are using them because they don't have any savings or any kind of an emergency fund," says Smith. And they get caught up in a cycle of debt.

"On top of high interest rates, there are late fees, processing fees and charges for non-sufficient funds," says Eisner. "We know of consumers calling these companies and saying 'I need you to hold my cheque, don't cash it' and most companies process it anyway, knowing the funds aren't there."

If your credit rating is holding you back from getting a conventional loan, taking out and repaying payday loans will not help you in the long run. "These debts aren't reported to the credit bureaus," says Smith, so they will not bolster your credit rating to make you more attractive to a bank, which offers cheaper products.

"If you have no savings and you can't pay the loan with your current pay cheque, you're not going to be able to pay it out of your next pay cheque either," says Smith.

Better, cheaper alternatives
Before opting for a payday loan, make sure you've exhausted all other possibilities. You've probably asked friends and family to tide you over, but have you contacted your creditors?

If the reason you need $100 is to pay your phone or cable company, call them and tell them you are having financial trouble. They have the authority to give you some time to pay it off or arrange a smaller payment, and their late fees and interest rates are better than any payday loan you could find.

Some employers will also advance you money on your pay cheque. You may be better off asking your boss than turning to one of these lenders.

Your other option is to find a local, nonprofit credit counselling service. They may be able to work out a repayment plan for you. "We do it all the time," says Eisner. "It's a short-term fix, it's not a debt management program -- that's a bigger program. For something this small, say $1,000, we may be able to make an arrangement with your creditors."

No matter how far in debt you are, this is an option for you. "We don't refuse anyone service," he says.

Jasmine Miller is a writer in Toronto.