One of the claims you hear 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. More restrictions on payday lending is being called for in the financial reform bill because of this supposed high interest. It seems like this is just trying to fix what isn’t really the problem.
Source for this article: Claims of high interest from payday lenders involve bad math
What actually is APR?
APR actually 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. 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.
So, let us assume a person borrows $ 200 and is charged $ 15 in fees for a loan that is due in 14 days.
$ 15/$ 200 = 0.075
365 days/14 days = 26.0714
You will next need to multiply the two figures:
0.075 X 26.0714 = 1.955
Multiply what you get there by 100: 1.955 X 100 = 195.5 APR
Now, the going assumption is that this APR rate would compound again and again were the loan to extend over the entire year, which it certainly does not. This loan is only for 14 days, not 365.
A more accurate pictures of APR
It would like this when taking the view of paying $ 15 every two weeks of the year:
$ 15 per every two weeks, and 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
Even though the 195 percent matches the figure above, one who gets a payday loan or cash advance of $ 200 with a $ 15 fee will only be paying $ 215, not $ 390.
Next we will take a look at the total sum:
$ 200 + $ 15 = $ 215 Less the principle for the difference in total paid:
$ 215 – $ 200 = $ 15
If we divide that over the principal:
$ 15/$ 200 = .075, or 7.5 percent
That doesn’t seem usurious to me
Targets that are easier
Credit card interest does compound monthly, unlike payday loans. You also are never going to close that credit card after opening it for two weeks. 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?
Citations
Annual Percentage Rate
http://en.wikipedia.org/wiki/Annual_percentage_rate
prnewswire.com
