
Are you tired of living paycheque to paycheque? If you've ever been in a position where you're strapped for cash, there's a chance you considered payday loans to make small purchases until your next payday. Seems pretty straightforward, right? Wrong. Most payday loan companies are notorious for taking advantage of borrowers, which, at the end of the day, is how they make their money.
Before considering a payday loan, let's take a closer look at how lenders make a profit off of payday lenders so you can decide whether or not this type of loan is right for you.
What is a payday loan?
Payday loans are a type of short-term unsecured loan that requires no credit check and immediate cash. Typically, payday loan borrowers can borrow between $500 and $1500, depending on the lender. The idea behind payday loans is that in a financial emergency, payday loan users will be able to borrow money to cover their bills and pay back the entirety of the payday sum by their next payday.
How do payday loans work?
We get it--at a glance, payday loans seem like a great option if you need financial assistance. So, how exactly do they work? To get a payday loan, you can either apply with online payday lenders or in person at a payday loan business in your neighbourhood.
If you've chosen online payday loans, your lender will transfer the money directly into your bank account the same day or the next. But first, the majority of payday lenders will get you to provide a signed, posted-dated cheque or your permission to withdraw the owed funds directly from your savings account when your salary loan is due, which can vary between two weeks and a month. In-person payday lenders will likely require you to return to their location to make your loan repayment. However, if you do not show it, they will run your signed cheque.
Now, if a borrower fails to repay the loan in time, you do have the option of renewing the loan or having it roll over to your next paycheque, which is when your payday loan debt will begin to snowball.
Are payday loans secured or unsecured?
A payday loan is a type of unsecured loan, given that borrowers are not required to put forth any collateral in order to borrow money. In contrast, a secured loan requires borrowers to sign over a high-value asset, like their home or vehicle, in order to qualify for said loan.
The purpose of collateral is to provide lenders with a security blanket if a borrower defaults on their loan amount, which means they are unable to pay back their loan. In this scenario, the lender would then be able to seize the asset to make up for their losses.
Are payday loans revolving or instalment?
Payday loans are not revolving or instalment forms of credit, as you will need to pay back the entirety of the payday loan within 2 weeks of the money hitting your bank account. In contrast, credit cards and other revolving credit accounts let you borrow and pay back money as needed, whereas instalment loans are paid back over time in smaller sums.
Is a payday loan a fixed-rate or variable-rate loan?
Payday lenders will charge borrowers a fixed rate when borrowing money. Depending on the province you live in, there are regulations for interest rate caps, which is how much a payday lender can charge you per $100 you borrow, which we’ll talk about a little later.
How do payday lenders make money?
Payday lenders are notorious for charging very high interest rates and are often described as a form of predatory lending by financial experts and traditional financial institutions. While payday loans have very few restrictions when it comes to who is accepted for a loan because payday loans are high-interest loans with short repayment terms and several added fees, payday lenders often prey on individuals experiencing financial difficulties, which is how they make their money.
Most provinces have caps on how much payday lenders can charge per $100 payday borrowers seek to borrow and non-payment fees. Here's a quick breakdown by province:
Province
Maximum borrowing per $100
Maximum non-payment penalty
Alberta
$15
$25
British Columbia
$15
$20
Manitoba
$17
$20
New Brunswick
$15
$20
Newfoundland and Labrador
$14
$20
Nova Scotia
$17
$40 (default penalty)
Ontario
$15
$25
Prince Edward Island
$15
Unknown
Saskatchewan
$17
$25
Quebec
$15
$25
Let's say you live in Nova Scotia and need to borrow $500 from a payday lender. With a fee of $17 per $100 borrowed, you'd need to pay back $585 within two weeks. To put this into perspective, your 17% rate becomes a 443.21% Annual Percentage Rate (APR), while a virtual credit card in Canada has an average APR that maxes out at 25.99%.
Now, let's say something happened with your paycheque, and you aren't able to make your payment back to your payday lender. You'd then be charged an additional $40, bringing your total to $625 and counting for each month you're unable to pay back your loan, which can be a debt trap for many Canadians who aren't able to manage their money responsibly, which is exactly what most payday lenders are looking for.
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What happens if you can't pay back the money you borrowed from payday lenders?
Payday loans are all fun and games until you're unable to make your payment on time. Depending on which province you live in, the consequences can be quite severe and may include the following:
You may be charged a fee by your payday lender if you do not have enough money in your bank account at the time they go to withdraw the amount owed.
Your financial institution may also charge you an insufficient funds fee (NSF) for not having enough money in your bank account. Consider overdraft protection coverage to prevent this.
Your payday lender will likely charge you interest on the amount owed until you are able to pay it back in full.
The total amount owed to your payday lenders will continue to increase, putting you in a cycle of debt that can significantly worsen your overall financial situation.
Your inability to pay off debt from your payday loans may be sent to a collection agency, which would then be listed on your credit report.
Why are payday loans bad?
Even though a payday loan can help you secure fast cash, it goes without saying that payday loans are bad for several reasons, including the following:
High interest rates
Payday loans are considered high-cost loans given their inflated interest rate, fees, and compounding costs compared to other personal loans available. If you can, consider other types of loans before settling on a payday loan.
It can be difficult to repay the loan
When you get a payday loan and are unable to manage your finances correctly, it's easy to get stuck in a cycle of debt that can put you in a worse financial spot than you were before applying for your payday loan.
They don't help you credit
If you're unable to pay back your payday loans, your payday lender will likely send your information to collections, which can impact your overall credit score. Additionally, while a traditional personal loan can help build credit, payday loans don't, as they don't run a credit check before approving you.
Do payday loans hurt your credit?
Yes, as we just mentioned, this type of small-dollar loan will not help your credit in any way. Because payday lenders don't run a credit check, they won't send your payment to credit bureaus indicating that you have paid on time. The only scenario where payday lenders will send your information to a credit bureau is if you fail to meet your repayment terms, which will negatively impact your overall credit history.
Are payday loans legal?
While payday lending can be seen as predatory, it is still legal in Canada. The Canadian Criminal Code prohibits lenders from charging annual percentage rates above 60%. Payday lenders are exempt, given that payday loans are capped at $1500 and are short-term loans. Additionally, because payday lending is regulated provincially and isn't technically listed in the Criminal Code, payday loans operate in a grey area that enables them to operate as they do.
Keep in mind that while payday loans are technically legal in Canada, the payday industry essentially functions because it offers quick cash advances to those who need money quickly and are not in the best financial situation, to begin with. If you can, avoid a payroll loan and seek other borrowing options before applying for this type of loan.
What information do I need to apply for payday loans?
To apply for a payday loan, you'll need to provide a payday lender with the following information:
A valid photo ID.
A bank account number.
A valid paycheque.
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How can I get a payday loan?
If you're still interested in applying for a payday loan, there are a couple of steps you need to take before being approved. Here's what you need to do:
Shop around
First things first, you need to shop around and compare fees and interest rates from different payday lenders. Payday lending fees can vary based on who you apply with. So, make sure to look at a couple beforehand so, at the very least, you can get an affordable rate.
Apply for your payday loan
Once you find a payday lender with a fee and repayment term you're comfortable with, you'll need to go into their store or apply online. Remember, while a payday lender will not run a credit check on you, you'll still need to provide a valid ID, your bank account number, and a valid paycheque.
Most of the time, you'll be approved for your payday loan within minutes or 24 hours, depending on which payday lending service you choose.
Ensure you pay back your cash advance loan
Once your payday loan is deposited into your account, you can go ahead and use the funds to pay your emergency bills. Just remember that you'll need to pay your short-term loan back within two weeks to prevent your non-payment from being sent to credit bureaus and putting yourself in a worse financial spot than before.
Alternatives to payday loans
Okay, now that we've established that payday loans are bad, what other options do you have if you need to borrow money in Canada?
Slush fund
While a slush fund is technically your own money, it can be a great way to streamline your plans for spending and saving. Essentially, a slush fund, similar to an emergency fund, is an emergency fund set aside to cover unforeseen bills or leisurely expenses. Unlike a typical budget that you allocate money to each month, a personal slush fund offers more flexibility.
Ultimately, a slush fund can be used for unexpected expenses that pop up throughout the month, emergency costs, or even for last-minute tickets to see your favourite band play in town. This flexibility allows you to enjoy your money and gives you a bit of security when you need to pay for unanticipated costs.
Ideally, if you want to make money on the funds you deposit into the bank, you may want to consider a high-interest savings account. These types of savings accounts allow you to get a bit of a return on the money you deposit and the ability to withdraw money at any time to pay for the things you need. Just make sure you avoid accounts that have withdrawal fees and other restrictions.
Borrow money from a bank or credit union
If you already have a bank account with a traditional financial institution or credit union, you may want to consider applying for a personal loan through them. Because you already have a working relationship with your bank, you'll likely be approved for a personal loan with a favourable interest rate and repayment term.
Increase the limit on your credit card
You may also want to consider increasing the limit on your credit card. A benefit to increasing your credit limit is that it'll likely give you enough leeway to pay your emergency bills without the risks associated with a payday loan. Additionally, while taking out payday loans does nothing to improve your credit, increasing your credit limit will, provided that you're able to make your minimum monthly payments and eventually pay off your credit card debt.
Just keep in mind that while a higher credit limit can help you pay for emergencies, it can also put you in a debt cycle if you choose to use your added funds for non-essential purchases.
Cash advance line of credit
A cash advance line of credit allows people to get access to cash quickly when they need it. In contrast to conventional loans, which provide a large sum of money upfront, a cash advance line of credit enables borrowers to access funds up to a preset credit limit as required.
You can usually get a cash advance from your credit card company through an ATM or by going to a bank directly or online, depending on who you bank with. Just keep in mind that before you choose this option, make sure to read the terms and conditions of your card to determine if there are any fees or inflated interest rates you should know about ahead of time.
Ask family or friends
Worst case scenario, before considering a payday loan, ask a family member or close friend to spot you the cash. Not only can you avoid interest rates, but you'll also have a bit more flexibility when it comes to repaying the loan.
Does paying back a loan impact your credit score?
Yes, generally speaking, paying off a loan can impact your credit in a good way. In the first place, it aids in building a track record of timely payments, which is an essential factor that lenders consider when granting loans to borrowers.
But there's a catch. Once your personal loans are paid off in full, rather than your credit score increasing, it may actually drop slightly. Why? Essentially, because you are no longer making active payments toward paying off your debt, there will be no activity on your credit report, which can impact your score.
So, how exactly are you supposed to fix this? The goal is to continue paying off your credit card debt on time and any other loans you may have to show credit bureaus that you can responsibly handle your debts. Additionally, adding to your credit mix the different types of loans you have can also improve your credit rating.
Are you unsure what your current credit score is? Get a free credit score check and build your credit with KOHO!
Can getting a personal loan help your credit score?
While a payday loan may not be the best option for most Canadians, getting personal loans can help your credit score and give you a bit more peace of mind when borrowing money. Here's a closer look at why opting for traditional personal loans can benefit you:
Diversify your credit mix
Your credit mix, AKA the type of credit you have, is one of the numerous factors that go into determining your credit score. Introducing a loan with installments broadens your credit mix and can improve your credit score if the majority of your credit profile is made up of revolving credit, like credit cards. Personal loans fall under installment loans as you'll pay a fixed rate each month for a specific amount of time.
Positive payment history
The biggest factor influencing your credit score is your payment history. It highlights the track record of your debt repayment. Your credit score can be significantly raised by creating a favourable payment history through regular, on-time, and complete personal loan payments. This will improve your credit report rating and make it easier to borrow money in the future.
Debt consolidation
Your debt-to-income ratio indicates how much debt you have relative to what you make each month. For this debt-to-income ratio to positively influence your credit rating, you'll need to keep it under 30%. If you have numerous debts and a high debt-to-income ratio, personal loans can help lower this by enabling you to consolidate your debt, which will improve your score over time.
Streamline your finances with KOHO
At KOHO, we help Canadians streamline their finances. Whether you're looking to get a cash advance, open a savings account, or improve your financial literacy on topics like surviving a recession, KOHO is pleased to offer several financial products tailored to your unique needs.
If you're ready to secure your financial future and take control of your financial health, partner with KOHO--we've got you covered.

About the author
Niki is a communications specialist with years of experience as a freelance and marketing agency content writer. With a knack for storytelling, Niki enjoys working with businesses from diverse industries to craft engaging content that resonates with target audiences worldwide.
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