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Paying the price: The cost of payday loans

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. Enter the payday loan, seemingly a saving grace in your time of need, promising immediate relief.

When we find ourselves in financial strife, it's tempting to look for a short-term fix – sometimes it’s payday loans; other times it’s through wage advance apps. But whichever you choose, it can cost you big time.

Before you sign on that dotted line, let's 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.

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.

 

 

How do payday loans work?

Here's how the process typically works:

• • 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.

What’s the reputation of payday lenders?

Payday lenders in Australia, such as Fundo and GDay Loans, have a mixed reputation. While they provide a service to individuals who may not qualify for traditional credit options, they have also faced criticism for their high fees, interest rates and lending practices.

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, just like Scott Futcher, who accumulated $10,000 debt that he can’t repay.

Payday loans are an expensive form of credit, and their high fees and interest rates can quickly accumulate, making it difficult for borrowers to repay the loans. In response to these concerns, the Australian government has introduced regulations, such as the 2022 updates to the National Consumer Credit Protection Act 2009, to protect consumers and impose limits on fees, interest rates and loan amounts. There’s also a recent proposal to lower the cap of the loanable amount.

Despite the regulations, the industry is often seen as predatory and exploitative. However, not all payday lenders engage in unethical practices. Some adhere to responsible lending guidelines and work to provide a valuable service to those needing short-term financial assistance.

What are wage advance apps?

Applications such as MyPayNow and BeforePay are designed to provide access to a portion of your earned but unpaid wages before your official payday. They offer a financial safety net, helping you avoid high-interest payday loans or overdraft fees in case of unexpected expenses or emergencies.

This rapidly growing market saw about $3.2 billion advanced in 2022, indicating the demand for such services. This is not surprising given there’s a battle for our digital dollars.

A third-party company, your employer or your bank can offer wage advance apps. Third-party apps are generally accessible to a wide range of users. They may offer additional financial tools, while employer-sponsored programs are directly integrated with the company's payroll system and may come with lower fees or even be free for employees. Bank-provided wage advance services offer the advantage of being associated with trusted financial institutions and may have additional financial assistance available.

While the features and fees of wage advance apps differ from one provider to another, there are some common elements, according to PressPay:

• • Often cheaper than other types of short-term loans - Pay advance apps generally have a flat fee of around 5 percent per transaction. However, this only remains affordable if you're able to make timely repayments; otherwise, additional fees and interest can quickly add up.
  • Same-day money access - One of the key selling points of wage advance services is the quick access to funds. Most providers complete the money transfer within minutes, giving you the immediate relief you seek.
  • Automatic deductions - To simplify the repayment process, your borrowed money is automatically deducted from your bank account once you receive your next pay cheque. This means you don't have to worry about remembering to make the payment yourself.
  • No credit checks - Most pay loan providers do not conduct credit checks, so you can apply even if you don't have a good credit history. This can be both a blessing and a curse, as it may allow you to access funds when other options are unavailable, but it can also lead to taking on debt without fully understanding the risks involved.

What’s the difference between wage advance apps, payday loans and BNPL?

Wage advance apps provide short-term cash advances based on your earned income. By allowing users to access a portion of their earned wages before their scheduled payday, these apps can help meet immediate financial needs. Wage advance apps typically charge low or no fees; some operate with a voluntary tipping system or a small subscription fee. Since these apps base their services on your earned income, most do not require a credit check. Additionally, repayments are generally automatically deducted from your next pay cheque, which can simplify managing your finances.

Payday loans are another form of short-term cash advance designed to help borrowers with immediate financial needs. However, they differ from wage advance apps in several ways. Payday loans are known for their high fees and interest rates, which can lead to annual percentage rates (APR) of 400 percent or more. These loans usually have short repayment terms, typically two weeks or until your next pay cheque, making it difficult for borrowers to repay on time. This often results in rollovers, extensions, and additional fees. Payday lenders may also require a credit check, impacting your credit score. Due to the high costs and short repayment terms, payday loans can lead to a cycle of debt where borrowers continually take out new loans to cover previous ones.

 

 

BNPL lets you buy and pay for goods or services later, typically through interest-free instalments. BNPL services are often offered by retailers or third-party providers at the point of sale, online and in-store. Unlike wage advance apps and payday loans, BNPL is tied explicitly to purchases, not cash advances. The primary difference between BNPL and other short-term loan options is the repayment structure. BNPL plans usually involve interest-free instalments, making them a more affordable option. However, late payment fees may apply if you fail to make timely payments, and you’ll still pay more than paying in cash.

Are wage advance apps regulated in Australia?

These apps do not fall under the same regulatory framework as traditional lenders, as they do not typically lend money in the same manner. However, these apps are still subject to general consumer protection laws and financial regulations.

The Australian Securities and Investments Commission (ASIC) is the regulatory body responsible for overseeing the financial services industry, including some aspects of wage advance apps. ASIC's regulatory purview extends to ensuring that these services comply with consumer protection laws, disclosure requirements and fair business practices.

Moreover, some wage advance apps may be required to hold an Australian Financial Services (AFS) licence, depending on the specific services they provide. For instance, an app offering financial advice or dealing with insurance products would need an AFS licence.

While no specific regulation is tailored exclusively for wage advance apps, the Australian government and regulatory bodies are closely monitoring the sector as it evolves, and many are calling for a crackdown.

What's the reputation of wage advance apps in Australia?

Their reputation varies depending on individual experiences and the specific app being used. Some people view these apps positively, as they provide a more affordable and convenient way to access earned wages before payday, helping to cover unexpected expenses or financial emergencies.

Wage advance apps often have lower fees compared to payday loans and promote responsible borrowing by limiting the amount that can be advanced. Additionally, they may offer financial tools such as budgeting assistance or savings features, which can help users manage their finances more effectively.

However, critics argue that wage advance apps can still lead to a cycle of debt if used irresponsibly or relied upon too frequently. These apps might normalise borrowing from future earnings, potentially causing users to become dependent on the service and struggle with long-term financial stability. It’s precisely what happened to Sharmy Walker, who has borrowed almost $8500 over several years.

BeforePay CEO Jamie Twiss maintains that wage advance apps are not harmful, like predatory payday lenders, but provide a more affordable and responsible alternative for people needing short-term financial assistance.

The high cost of quick cash

At first glance, payday loans and wage advance apps 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.

The main culprit here is interest. Payday loans in Australia are notorious for their sky-high interest rates, which can be upwards of 20 percent per month. To put this in perspective, a traditional personal loan might attract an annual interest rate between eight and 15 percent.

So, what does this mean for you? Let's say you borrow $500 to cover an unexpected expense. If you don't pay it back within a month, you could end up owing an additional $100 in interest. And if you can't pay it back the following month? That interest compounds, and before you know it, your $500 lifeline has turned into a $1000 debt, and it's still growing.

The same goes for wage advance apps - if you rely on them too often, you'll likely be trapped in a debt cycle. For example, let's say you borrow $200 every two weeks and pay a 5 percent fee. Over a year, you would have paid $260 in fees alone. This effectively turns into an annual interest rate of 130 percent on your advances, significantly higher than what you'd pay on a traditional personal loan.

Here is how we calculate the annual interest rate.

Key numbers

The amount of credit the borrower will receive (Amount Financed) = $200

The dollar amount the credit will cost (Finance Charge) = $10

Term of the loan = 14 days

Calculating the annual interest rate

Step 1 – Divide the total Finance Charge ($10) by the Amount Financed ($200) = 0.05

Step 2 – Multiply the answer (0.05) by the number of days in the year (365) = 18.25

Step 3 – Divide the answer (18.25) by the term of the loan (14 days) = 1.3035

Step 4 – Move the decimal point to the right two places and add a percent sign = 1.3035 becomes 130.35% annual interest rate

The debt trap

And therein lies the danger of these loans: 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.

 

 

The trap is insidious. 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.

Think twice, borrow wisely

None of this is to say that you should never consider a pay loan. In some cases, it might be the best of a bad lot. But if you're thinking about taking out one of these loans, it's crucial to understand the potential consequences fully.

Take the time to explore all your options. Other ways to access emergency funds in Australia include no or low-interest loans provided by community organisations and government initiatives.

The No Interest Loans Scheme (NILS), for example, offers low-income earners assistance to buy appliances, such as heaters and refrigerators, and pay for some other services, such as car repairs. It is not a payday loan or bank loan and can only be used for specific purposes.

Financial counselling services are also available to help you navigate your situation and make an informed decision. To find a financial counsellor near you, visit the National Debt Helpline or call 1800 007 007.

Remember, there's no shame in seeking help when you're in a bind. But it's essential to understand the real cost of that help. Payday loans might seem like a quick fix. But in the long run, they can make a difficult situation much, much worse.

As always, if you have a complaint about one of these lenders, please lodge it with us, and we’ll help you handle it.