Perhaps the most common, and often times only, criticism of payday loans is their high APR. With traditional business loans and mortgage loans having anywhere from 5-30% APR, its no wonder 400% APR sounds astounding. But its not as bad as it sounds.
APR stands for Annual Percentage Rate. Since most traditional loans are given for long periods of time, the interest you pay on the loan is measured by how much interest you pay annually. So if you have a 12% APR, then each month you pay 1% of your balance in interest. If you have $1,000 outstanding, then at the end of the month your outstanding balance will become $1,010.
Of course, your monthly payment could be something like $50, meaning next month’s outstanding balance will be $960. After interest is added,your new outstanding balance is $969.60. You pay your normal $50 and eventually this cycle continues enough times that you pay off the loan in full.
Payday loans are very different. In essence,a payday loan is an advance on your paycheck. If you need money immediately, but aren’t getting paid for another 10 days, then you can get your paycheck advanced to you for a fee. This fee is generally around 400% APR.
But what does this mean? It means in the 10 days you have your loan, you will pay about 11% of the loan amount in interest. If you borrow $300 for those 10 days, you will have to pay back $333 at the end of the 10 days.
So where does 400% come from? Well, if you had a payday loan out for an entire year at the previously mentioned rate, you would pay 400% in interest. Of course, the fallacy here is in measuring payday loan interest in years when loans last only a few days.
Payday loans are designed to be smaller amounts for short periods of time. The only way to make money of small loans for short periods of time is to have a high interest rate. Of course you will never pay 400% of your loan in interest, that’s just what it makes out to be over the course of an entire year.
We don’t measure our shoe size in miles, so why do we measure our payday loan interest in APR? It makes no sense whatsoever. Banks don’t have to measure their NSF and bounced check fees in APR. Good thing too, because they are well over 1,000% APR! Yet no one accuses them of predatory lending…
The truth is the critics are just trying to find ways to put payday lenders out of business. They say payday lenders deceive people and don’t want them to be educated about the “truth” of payday loans. Well the truth is that law requires the APR to be prominently displayed in any payday loan location.
Payday lenders are not afraid of the truth and would gladly have more people be educated about payday loans and understand how they really work…starting with the critics who want payday loans banned.
