July 28, 2017/ Published 9:30 AM EST / Alyssa Charles, Staff Writer

Your high-interest loan is hurting your financial plan

You’re frustrated. You’re working hard, but not making enough. So to deal with the frustration, you tell yourself “I deserve more,” and treat yourself with a bit of retail therapy. If that sounds familiar, you’re not alone. In fact, the average Canadian carries over $22,000 in consumer debt. To quote Edward Norton, “we buy things we don’t need with money we don’t have.”

The Walrus recently explored how middle-income Canadians are borrowing and living beyond their means in order to “keep up with the Joneses,” and while borrowing money isn’t new to Canadians, the increasing use of easily-accessible, high-interest payday loans is. Last year, the household use of high-interest short-term loans doubled to 4%.

4% seems like a small number, right? Wrong. With over 13 million households in Canada, 4% breaks down to more than half a million households using short-term (and high-interest) loans. 90% of Canadians who take on payday loans use them to cover necessary expenses or avoid late charges on bills, and 43% of them don’t realize that those loans are more expensive than credit card advances. Here’s a not-so-fun-fact: payday loans can charge an interest rate of up to 500% per year.

A 2016 Equifax report revealed that many people have little or no consumer debt, but those who do are borrowing more and more. If you’re taking out a loan to cover day-to-day expenses or pay bills, it’s time to sit down with an advisor to reevaluate your financial plan.

Consider this scenario:

Charles and his wife Rachel, have a combined annual income of $145,000 (approximately $7,000 monthly), with their retirement contributions and health and dental insurance automatically deducted from each pay cheque. They bought a house five years ago, and have a monthly mortgage payment of $3,400. Charles and Rachel also recently had a baby, and now that Rachel has gone back to work, they spend $1,000 a month for childcare. On paper, Charles and Rachel are doing quite well. But there’s always more to it than meets the eye, so let’s explore the rest of their expenses.

Monthly, Charles and Rachel spend $900 on groceries and household supplies (including diapers), $745 on car payments and insurance, $140 for transportation (Charles takes the subway to work), $200 on cable and internet, and $300 for miscellaneous expenses, totaling $2,285 in expenses plus $4,400 in housing and childcare costs. The grand total? $6,685.

Once all of their expenses are paid, the couple has about $300 left each month.

So that covers their monthly expenses, but like most Canadians, Charles and Rachel are also carrying some credit card debt. Between using their credit card to pay for a family vacation and to cover some expenses while Rachel was on mat leave, the couple owes $9,500 on their credit card, which has an annual interest rate of 17.5%. They’ve been carrying a balance on the card for the past 2 years and with their current expenses, they haven’t been able to reduce their credit card debt by much. If they use the $300 remaining at the end of the month to repay debt, they won’t have a safety net for unexpected expenses. They’ve considered taking out a high interest loan to help pay off their credit card bill, however a $9,500* loan will cost them an additional $7,010* in fees and interest, and requires them to repay the loan in just 24 months.

Repayment Option

Time to pay back loan

Interest

Monthly payment

Total repaid

Money from chequing account

43 months

17.5%*

$300*

$12,900*

Short-term high interest loan

24 months

APR: 59.9%*

$687.92*

$16,510*

While the high-interest loan will help Charles and Rachel repay their credit card debt faster than using money from their chequing account, they’ll end up paying way more in interest. In the long run, it isn’t worth it to take on more debt to repay an existing debt. To pay off the loan in the required 24-month window, Charles and Rachel need to pay $687.92 monthly – but they only have $300 per month to spend.

Repaying high-interest short-term loans can be extremely challenging when you don’t have much disposable income after managing household expenses – especially if you’ve taken out more than one payday loan. If you need some help figuring out your financial plan, connect with one of our advisors today.

*These figures are for illustrative purposes only and assume that bills are paid monthly.

Related articles