If you ask an average person what is his or her idea about how much interest lenders charge their borrowers in Canada, most people will answer that this rate is somewhere between 4% on mortgages and lines of credit for borrowers with a superior credit rating and around 20% on credit cards. But only few people know that there is a large number of loans taken every day in Canada charging 600% (that’s right, six hundred per cent) per year and even more. What is especially interesting, even most borrowers who take those loans have no idea that they are paying such an astronomical interest rate.

We are talking about so called payday loans. These loans are short term loans, usually for a period of up to two weeks, which a person can take with an intention to repay when the next paycheque comes in. Normally, there is no credit check and the only requirement is some form of confirmation that your next paycheque is coming. The quoted interest usually doesn’t look too high because the borrowing period is very short. Some lenders even provide “interest free” loans. But in addition to the interest, if any, they usually charge various fees which may be called something like a setup fee, and administration fee, etc. For example, www.mrpayday.com will charge you $60 for a $300 loan for ten days. $60 is only 20% of $300, but on the annual basis it will be 720%. Under the new provincial legislation, these charges will be limited to 600% per year, which is still astronomical compared to all other forms of borrowing.

So why is this number so incredibly high? And why do people use these loans? The answer lies in the type of borrowers who apply for these loans. Payday loan companies deal with borrowers who wouldn’t qualify for any traditional form of credit. They can’t get a line of credit from a bank and in many cases even a credit card. This means that they are very likely to default on the loan. And they do. Payday loan companies are not super profitable. They operate in a saturated market with intense competition, which means that they can’t charge more than others do. And the default rate in this business is so high that the only way to operate at a profit is to charge exorbitant rates. This also explains why there is demand. When you are facing eviction if you don’t pay your rent this month or when you need to buy groceries to feed your children, $60 for a $300 ten day loan is probably something you will be willing to pay, especially if this is your only option.

These terms do seem unfair, and there is an opinion that such business practices shouldn’t be allowed. But until the underlying social problems in our society are fixed, payday loans remain the only survival option for many.

Nikolay Sisan is a Certified Financial Planner and freelance writer in Vancouver.