Payday Loan Interest Rates
Posted on Wednesday, July 14th, 2010 at 11:22 am in Financial Planning, Helpful Payday Loan Info
We receive many questions from customers on our site regarding the interest rate on payday loans. Fees from payday loan lenders vary drastically from lender to lender and from state to state. Some states restrict the finance fees a payday lender can charge, while other states allow lenders the freedom to set their own reasonable fees. Because of the variation between lenders and state payday loan laws, it’s difficult for us to provide a simple answer to this question. Instead, we’ll provide you with a way to calculate the annual percentage rate (APR) on a payday loan for yourself.
Understanding Payday Loan APR
Before calculating the payday loan interest rate, you should understand what the annual percentage rate really means. Congress is responsible for the creation of Annual Percentage Rates (APRs) as a more reliable method of comparing the costs of long term loans and credit. Credit card companies were providing calculations for the simple interest on their payment plans, misleading customers on the true cost of interest rates over a full calendar year. To encourage honesty in credit and lending, Congress passed a law in 1968 requiring all lenders and credit card companies to list the annual percentage rate on their loans to help consumers better compare credit costs.
Payday loan lenders must also provide customers with a calculated APR under federal law, but short term payday lending differs from other types of credit and bank loans. The principal amount and interest on a payday loan are paid back in full at the end of a two-week or one-month lending period, not over the course of a year or several years as in the case of credit cards or a home loan. The calculated APR for a 14-day payday loan results in a 3-digit interest rate, but you must keep in mind that this rate would only apply if you repay your payday loan over the course of a year or more. If you repay your payday loan at the end of the 14-day or one-month period, your percentage will actually be much lower.
Calculating Payday Loan APR
To calculate the APR on a payday loan, divide the lending fee by the principal amount borrowed. Take the resulting decimal amount and multiply it by the number of days in the year, 365. Finally, divide the resulting number by the lending term (usually 14 days or 30 days). Move the decimal point in the answer over two places to the right to get the APR. Here’s an example using a $15 charge from a payday loan lender on $100 borrowed for 30 days:
Divide the fee by the principal: $15 / $100 = 0.15
Multiply the decimal amount by the number of days in a year (365): 0.15 * 365 = 54.75
Divide the answer by the length of the term, 30 days in this case: 54.75 / 30 = 1.82500
Moving the decimal point over two places to the right gives us an APR of 182.5% for a $100 loan borrowed for 30 days from a payday lender with a $15 service fee. Again, this example APR only applies if the borrower repays the loan over a year or longer, not if the loan is repaid in full at the end of the 30 day period.
Now that you know how to calculate the APR on a payday loan, you can determine the credit cost for yourself and decide whether the cost is worth the convenience value.
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