How do payday loans work?

Posted on 1 February 2022

Written by Ashvin Sharma

Payday loans are high-interest loans that are taken out to tide you over for the short term. They get the name ‘payday loan’ from the idea that you will need to repay the loan within your two-week payday cycle. They can be a helpful way of providing quick access to funds you may not be able to get from other conventional loan systems. Payday loans are controversial as they may be considered to take advantage of Canadians who need urgent support while they await their next paycheque. They can be very expensive if not repaid on time, and can lead to payday loan debt. So, how do payday loans work? And what if you cannot repay them on time? In this article, we explain all you need to know about payday loans, how they work, and the consequences of not repaying your payday loan on time.

What is a payday loan?

Payday loans are short term loans that come with a high interest rate. They offer quick access to much needed funds from a third party lender, as opposed to conventional lenders like banks or financial institutions. Payday loans get their name from the idea that you repay the loan on your next pay day, in line with a two week pay cycle. Usually, you will be able to borrow up to 50% of your take home pay on your next paycheque. Payday loans come with high fees that make them a very expensive way to borrow money. In Alberta, British Columbia, Manitoba, New Brunswick, and Ontario, you have up to 62 days to repay a payday loan. If you cannot repay your payday loan on time, you will face additional fees and interest rate payments, which will increase your overall debt. For this reason, you should avoid relying on them for everyday costs and bills, and should always try to repay it on time.

How do payday loans work?

If you go to take out a payday loan, it may be at a physical lender or online. Typically, payday lenders will want to see evidence of a regular income, a bank account, and a permanent address. Before they will approve a payday loan, they will also ask you to complete a form permitting them to withdraw the total loan amount from your bank account when it is due, or for you to provide a post-dated cheque for the total loan amount including fees. If you are granted a payday loan, the money will be deposited into your account or given in cash. It is possible to get given the money on a prepaid card also. When it comes to loan repayment, you will probably need to pay at the same place you took your loan out. For this reason, when you come to sign your payday loan agreement, you need to carefully read it and ensure you understand the terms and loan costs including any fees or interest rates. You should also be extremely wary of any payday lender – many do not have licenses or follow provincial rules. Do not use any online payday lenders outside of Canada as they come with greater risk.

What are the risks of a payday loan?

There are a number of risks associated with taking out a payday loan. First of all, you need to make sure you are borrowing from a licensed payday loan lender in Canada. You can check this via your federal or provincial consumer affairs office to make sure they are a licensed lender. Another risk of payday loans is not being able to make your repayment. Payday loan interest rates are calculated on an annualized basis, and interest rates are much more expensive than other financial products like credit cards and regular bank loans. In fact, payday loans can charge up to a whopping 400%, while regular bank loans may charge 5% per year. While the demand for payday loans appears to be growing in Canada, they are often highly criticized for their extortionate interest rates and lack of flexibility in terms. Payday loans require one full repayment, complete with interest, and become much more expensive if you cannot make it on time.

How much do payday loans cost?

Payday loans are expensive ways to borrow money because you pay high fees, and you may have additional fees if your payment does not go through for any reason. This can make your loan even more difficult to repay which can lead to increased stress overall. In Canada, payday lenders must state their rates upfront as an annualized percentage rate (also known as APR). This makes it much easier for consumers to compare rates of financial products, no matter how long the loan or credit may be needed for. Limits for these interest rates are regulated by the provincial government. Here are the interest rates per province:

ProvinceMaximum charge
per $100 loan
Annualized percentage rate
for payday loans
(based on a two-week loan)
British Columbia$15391%
New Brunswick$15391%
Newfoundland and Labrador$21548%
Nova Scotia$19495%
Prince Edward Island$15391%

What if you cannot repay your payday loan on time?

Given the expensive nature of payday loans, there are some consequences to be aware of if you are unable to repay your payday loan on time. Depending on your province of residence, these consequences include being charged if you do not have sufficient funds in your account. There could also be continued fees if your situation does not change. Other consequences include your payday lender calling your family, friends, or employer to try and collect the money from you. They may also engage a collection agency, pursue legal action against you, seize your property, or get a wage garnishment order against you. For this reason, it is so important to seek debt relief as soon as you feel you may need it. As soon as you are able to share your situation with a reputable Licensed Insolvency Trustee, the sooner we can help you to find an appropriate debt relief solution. You will feel a huge weight lifted from your shoulders.

What are the best payday loan alternatives in Canada?

Before you take out a payday loan, you should make sure you can repay the loan on time, as well as covering your regular expenses. If you do not think this is possible, there are a number of payday loan alternatives out there. You should consider alternatives before you decide to take out a payday loan. Here are the best payday loan alternatives in Canada:

  • Ask for a pay advance from your employer
  • Borrow money temporarily from family or close friends
  • Get a line of credit from your bank or financial institution
  • Get a cash advance on a credit card
  • Get a personal loan from your bank or financial institution
  • See if you can cash in vacation days
  • Ask for additional time to pay your bills – depending on who you owe money to, they may allow you extra time to find a means of repaying them

If you are still wondering ‘how do payday loans work?’, reach out to the team at Spergel. You can book a free consultation at a time that suits you, and one of our Licensed Insolvency Trustees will work with you. We can review your financial circumstances, look at payday loan alternatives for you, and find a debt relief solution that will give you a fresh financial start.


Ashvin Sharma

Ashvin Sharma is a Chartered Insolvency and Restructuring Professional and LIT (Licensed Insolvency Trustee) overseeing all of Spergel's offices in the Greater Vancouver Area and British Columbia. He is also our resident expert on homeownership debt and health debt. In his spare time, Ashvin loves to play sports, spend time with family and friends, and serves as a volunteer coordinator for "Free-Them", a Canadian organization committed to raising awareness about human trafficking.

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