A claim often stated about payday lenders is that the APR charged for payday loans is more than 100 percent per year. With one view on it, that might be the truth. The supposed high interest is among the reasons that the financial reform bill calls for further restriction on payday lending. It seems like this is just trying to fix what isn’t really the problem.
What actually is APR?
Actually, APR stands for Annual Percentage Rate. APR can be calculated in different ways, and standards differ between institutions and by regulations of any given country, but that is a different topic. Anyway, the way the figures for the fees for payday lenders are calculated, according to prnewswire.com:
APR = [(interest rates or fees/amount being loaned) X (days of one year/the term of the contract)] X 100.
For a loan due in 14 days, let’s assume a person borrows $ 200 and is charged $ 15.
$ 15/$ 200 = 0.075
365 days/14 days = 26.0714
Now, we multiply those two figures:
0.075 X 26.0714 = 1.955
Multiply that by 100: 1.955 X 100 = 195.5 APR
That is going off the false assumption that the APR rate would compound again and again if the loan extended over the whole year. The loan will only be out for 14 days, not 365.
A more accurate pictures of APR
If one were to take the view that the fee of $ 15 were to apply to every two weeks of the year, it would look like this:
$ 15 every two weeks with 52 weeks per calendar year. There are 26 two week periods meaning:
$ 15 X 26 yearly two week periods = $ 390 total interest
Divide the total interest by the principal:
$ 390/$ 200 = 195 percent
Although 195 percent is the same as the figure above, someone with a cash advance or payday loan of $ 200 with a $ 15 fee will not pay $ 390, rather just $ 215.
Next we look at the sum total:
$ 200 + $ 15 = $ 215 The difference in total paid is less than the principal:
$ 215 – $ 200 = $ 15
If we divide that over the principal:
$ 15/$ 200 = .075, or 7.5 percent
That isn’t usurious to me
Easier targets
Unlike payday loans, credit card interest does compound monthly. You also don’t close a credit card two weeks after opening it. Thinking in those terms, are we sure that government should be regulating payday lenders with the financial reform bill before other forms of consumer credit?
More information on this topic
Annual Percentage Rate
http://en.wikipedia.org/wiki/Annual_percentage_rate
prnewswire.com
http://www.prnewswire.com/news-releases/the-truth-behind-the-numbers-what-aprs-really-mean-explains-pay1daycom-94574259.html
