Payday loans are one of the most expensive types of loans if not “the” most expensive. But are they really? A study by the FDIC Center for Financial Research found that payday loans may not necessarily yield extraordinary profits to payday lenders. Lenders charge a fee for their services but also have operating costs, which include default loses. After subtracting operating costs from the fees collected, the lenders don’t make that much money as it is commonly assumed.
Payday loans don’t carry interest rates. Instead, payday lenders charge a fee for their service. The fees very from lender to lender but are also regulated by local state laws. However, you can treat the fee you pay as an interest rate on the loan and calculate its APR.
The Annual Percentage Rate (APR) of a Payday Loan
The average payday loan term is two weeks. Lenders’ charges range from $15 to $30 on every $100 borrowed. This typically amounts to 400% to 780% annual interest (APR) or more. Payday lenders can’t charge lower fees for their services because they wouldn’t make any profit. For instance, if a payday lender decided to charge you 20% APR (compounded weekly) on a $100 one-week loan, he/she would generate only 38 cents profit, which would be much lower than his/her processing costs.
How much will a payday loan cost me?
Let’s say you want to borrow $1000 for two weeks. Depending on the state you live in the lender will charge you a different fee. Let’s say you live in New Mexico where the fees are capped at $15.50 for each $100 borrowed. The total amount in fees is $155 on a two-week loan. You will have to repay $1155 at you next payday. In fact you pay only 15.5% but it’s not the APR
- Divide the finance charge ($155) by the loan amount ($1,000)
- Multiply the result (0.155) by the number of days in the year (365)
- Divide the total (56.575) by the term of the loan (14)
- Multiply by 100
$155 : $1000= 0.155 x 365 = 56.575 : 14 = 4.04 x 100 = 404% APR
It is a good idea to be able to compare interest rates or APR’s between different lenders and choose the lender offering the lowest fee or APR.