The purpose of this research study was to look at the nature of existing payday lending services from multiple perspectives, including borrowers across Ontario, and to explore the possibility of a 'made-in-Waterloo Region' microcredit alternative to payday lending. The project idea was initiated by staff at CCBR and developed as a result of discussions with a few community partners. This project was funded by the Wellesley Institute.

Study Objectives

1. To explore the motivations of payday loan users in Kitchener-Waterloo area.
2. To seek to understand users' level of satisfaction about payday lenders/loans.
3. To research documentation of various alternatives to payday lending across North America and globally.
4. To do a preliminary needs assessment for alternatives to payday lending for low income people.
5. To explore with potential partner(s) who would be interested in implementing a viable social enterprise venture based on needs assessment.

For more information about the study and to read the full report, click here.

Background
A payday loan, also called a payday advance or pay check advance, is a small, short term unsecured loan to meet the borrower's expenses till his/her next payday. The borrower guarantees repayment with a post-dated check or pre-authorized debit. Typically, the loan amount ranges from $100 to $400 and it is usually due two weeks later. The interest rate charged is much higher than the banks or credit cards. The average loan interest rate can range from 330 to 650 % APR (annual percentage of rate), exorbitantly higher than the 60 per cent anti-usury clause in the Criminal Code of Canada.

Starting in the 1990s, payday loans have become increasingly popular in Canada. Approximately 1,350 stores operate in Canada, with over 700 in Ontario.

There are a number of reasons payday users might borrow money from payday lenders. The most important being the ease with which an individual can get the short term loan from payday lenders. There is no credit check performed and the paperwork is quite simple. According to a study done in North Carolina, various US based researchers have shown that most borrowers have significant credit constraints and poor credit histories.

Convenience of location and hours of operation are also some important factors. Payday lenders tend to stay open late, and they can be found in multiple urban and suburban locations. In some cases, the payday loans may meet the emergency needs of the borrowers, such as loss of income, car repair, job loss, etc. However, some borrowers become 'addicted' to using this money for 'non-essential' expenses, such as vacations, expensive meals, etc.

The proponents of payday lending argue that payday loan stores provide a service which is not available from other sources. They establish that many credit unions have attempted to offer similar products, with lower interest rates, but have been unable to do so without government grants or subsidies. A staff report released by the Federal Reserve Bank of New York concluded that payday loans should not be categorized as 'predatory' since they may improve household welfare. Moreover, they further assert, that payday stores extend credit to 'risky' customers with high chances of default.  

However, the critics term this practice as exploitative, taking advantage of people's financial hardships. They say that low-income borrowers are more likely to be trapped in a 'debt cycle' where they have to repeatedly renew the loan and pay charges or fees every two weeks until they pay off the principal amount to get out of this 'debt cycle'. Statistics compiled by the Centre for Responsible Lending show that the majority of the industry's profit comes from repeat borrowers who are unable to repay loans on the due date and instead repeatedly renew their loans, paying fees each time. Many payday lenders do not display in a prominent spot the interest rate they charge from the borrowers, if they display it at all.

This issue has been vastly under-studied in Canada. The first national Statistics Canada study on the issue was the Survey of Financial Security. It showed that "young families were 3 times more likely to have used payday loans" and that "low-income families (after tax) were fully twice as likely as those not in a low income bracket to have used payday loans-4.6% compared with 2.3%". This study is a start in understanding the nature of who uses payday loans, but a gap remains in understanding why they use them, and what alternative would work for them.

Significance
Studying the issue of payday loans was timely and relevant for a number of reasons. In the context of challenging economic times, we intended for our research to contribute to increased understanding of different motivations or factors that lead to individuals and families seeking payday loans at exorbitant interest rates. We hoped that this study would provide insights about different alternative(s) and come up with some 'out of the box' solutions to meet financial needs of low income individuals and families. Furthermore, in the spring of 2009, the Ontario government implemented a small number of regulations on the industry that were meant to curb predatory lending practices. Our study was taking place in the months following the implementation date, and we hoped to better understand the initial impact of these regulations on the borrowers of payday loans.

To our knowledge, this study was a first of its kind that seeks to explore the issue of payday loans, its motivations, and proposing alternatives in the Waterloo Region.