Paying the price: The cost of payday loans

Last updated on August 20th, 2024

Picture this: It's the end of the month, and you're anxiously waiting for your next paycheck. An unexpected expense throws your budget off balance, and you're desperate for a solution. An online search brings up payday loans in Australia and you are tempted by the promise of immediate relief.

When we find ourselves in financial strife, it's tempting to look for a quick fix but if you don’t pay the loan back quickly, even a small amount can end up costing you big time. Before you sign on that dotted line, take a closer look at what you might be getting yourself into.

What is a payday loan?

Payday loans are short-term, high-cost loans designed to provide fast access to funds until your next pay day. Lenders offering payday loans in Australia include Fundo, Credit24 and Fair Go Finance.

These loans are typically for smaller amounts up to $2,000, although some lenders offer up to $10,000. The loan term is anywhere between 16 days and 12 months.

They are an expensive form of credit, and while payday lenders can’t charge interest on loans under $2000, they can still charge high fees, making it difficult for borrowers to repay the loans.

 

 

Critics argue that payday lenders often target vulnerable individuals, such as those with low income or poor credit histories, who may not have access to other forms of credit. These borrowers can become trapped in a cycle of debt as they struggle to repay the loans and end up taking out additional payday loans to cover their expenses.

The Australian Government updated the National Consumer Credit Protection Act 2009 to protect consumers and impose limits on fees, interest rates and loan amounts. Legislation was also introduced banning payday lenders from offering loans that require individuals to pay back more than 10 percent of their income. In other words, no more than $10 for every $100 you earn after tax.

How do payday loans work?

While the terms and conditions may vary a little from lender to lender, pay advances in Australia will likely follow this process.

• • Application - You apply for a payday loan online or at a storefront location. The application process is generally quick and straightforward, requiring basic personal and financial information.
  • Credit check and approval - The payday lender may perform a limited credit check, but the approval process is usually more lenient than traditional loans. The primary focus is on your ability to repay the loan, which is often assessed by reviewing your income and employment status.
  • Loan agreement - Once approved, you will receive a loan agreement outlining the terms and conditions, including the loan amount, fees, interest rates, and repayment schedule. It's essential for you to carefully review the agreement and understand your obligations before accepting the loan.
  • Disbursement - After signing the loan agreement, the payday lender quickly disburses the funds as a direct deposit into your bank account or as cash at a storefront location. This can happen as fast as the same day or within a few business days, depending on the lender.
  • Repayment - You are responsible for repaying the loan and any fees and interest based on an agreed-upon schedule. Repayment is usually due on your next pay day, and the payment is often automatically debited from your bank account. Sometimes, you can repay the loan early without incurring additional fees.
  • Rollovers and extensions - If you cannot repay the loan on time, you may request a rollover or extension. However, this often incurs additional fees and can result in a debt cycle as you increasingly rely on payday loans to meet your financial obligations.

 

 

The high cost of quick cash

At first glance, payday loans and even pay advance apps such as MyPay Now and Before pay – which offer early access to a percentage of your weekly, fortnightly or monthly income – can seem like a lifeline. They offer quick access to funds when you most need them, often without the stringent credit checks that standard bank loans require. But this convenience comes at a high price.

You will be hard-pressed to find low interest payday loans. Payday lenders aren’t allowed to charge interest on loans under $2000, but their fees can quickly add up. They might be capped (20 percent establishment fee, 4 percent monthly fee and 200 percent default fee) but even on a small amount you can end up paying a lot more.

If you borrow $500, for example, to cover an unexpected expense you will pay back that amount, plus a $100 establishment fee and $20 for every month you don’t replay the loan. If you can’t pay it back within six months before you know it, your $500 lifeline has turned into a $720 debt, and it's still growing. A $2000 ‘lifeline’ could end up costing you as much as $3360 over a year.

The same goes for pay advance apps - if you rely on them too often, those fees can quickly accumulate. For example, if you borrow $200 every two weeks and pay a 5 percent fee each time, over the year you will pay $260 in fees alone.

 

The debt trap

The inherent danger of these loans is that they're a short-term solution to what is often a long-term problem. What will change next month if you're struggling to make ends meet this month? If you can't repay the loan promptly, you'll quickly find yourself trapped in a cycle of debt that is incredibly challenging to escape.

Some people take out another pay loan to repay the first one, thereby incurring even more debt and further exacerbating their financial difficulties. This cycle, often referred to as the “loan debt spiral”, can lead to severe financial hardship and stress. You are better off looking for alternatives to payday loans, such as negotiating to pay a bill in instalments or seeking assistance from a financial counsellor.

If you believe you are being unfairly treated by a payday lender, lodge a complaint with us and we’ll help you handle it.