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What Does APR Mean When It Comes To Payday Loans?

Updated on March 7, 2016

If you do any kind of borrowing, you should be familiar with annual percentage rate, or “APR”. This is a figure lenders quote that represents how much your loan is going to cost. On most loans, it takes into account not only your interest, but also other fees, such as closing costs. The purpose is to give consumers a figure that essentially acts as a common denominator, letting you compare different interest rates and charges.

Annual Rates for a Short Term Loan

As the name implies, “annual percentage rate”

is what you pay on interest and fees for a whole year. It’s easily applied to longer-term loans such as mortgages and car financing.

Payday loans are not intended to be carried out for this long. They usually have a term of 14 to 30 days, with the intention of tiding you over to your next pay check. Based on the way APR is calculated, shorter loan terms usually result in higher APRs, while longer terms produce lower ones.

Typical Fees for Short Term Loans

A typical short term loan has fees of about 15%. Assuming a two-week loan period, the only way the astronomical APRs so often quoted by critics would apply is if the loan rolled over, and was late by a factor of 26 times.

Whilst there aren’t any current regulations in the UK that stipulate a maximum amount of times a loan can roll over, many reputable companies limit this to 60 days.

Some Legitimate Concerns

Even though payday loans might be getting an unnecessarily harsh reputation because of the high APRs shown, there are some legitimate concerns with this type of borrowing. Even though most people aren't going to roll over a payday loan 26 times, they do roll them over.

Research from organisations such as the Office of Fair Trading and Citizens Advice shows that many lenders were in violation of lending laws, lending irresponsibly and failing to ask borrowers for evidence that they could repay. Critics also claim that payday lenders target people who are already suffering financially and that some payday loan providers even seem to encourage customers to borrow more.

Conclusion

Payday loans, like all other forms of borrowing, use APR as a comparison tool. This is an attempt to give consumers an understanding of the costs involved. Because APR really isn't designed to work well with any kind of short-term loan, the high figures often presented are somewhat misleading.

Many companies make it impossible to approach them by limiting the number of rollovers, and when you do the maths, they can be comparable to more traditional options such as overdrafts and credit cards. Just like any other type of financing though, it pays to do your research.


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