Payday loans tend to have a high APR because despite only lasting a few weeks or months, the figure is compounded over and over to make the product seem ‘annual.’ This results in an unrealistic and very inflated percentage which often exceeds 1,000%.
Payday loans are often criticised for charging high rates of APR and this number seems extra high when compared to products like mortgages (around 3% APR) and credit cards (18% to 30% APR).
However, there are a lot of misconceptions about payday loans and how APR is used to measure and compare financial products.
Why is APR used for payday loans?
APR is the international and most universal form of comparing the cost of financial products across the globe.
Whether it is personal loans, peer to peer loans
, car finance, mortgages or credit cards, APR is used as the yardstick and measurement of comparison.
According to FCA regulation, payday loan companies
must show the price of their products in the form of APR and this should help customers understand and compare the cost of borrowing across all financial products.
The interest is compounded for 12 months
The main issue with using APR as a measurement of comparison is that most products that use APR are annual products and stretch for 12 months or much longer e.g car finance and mortgages.
However, payday loans only typically last a few weeks or months and subsequently, the figure is multiplied and compounded over and over to make it appear to be an annual product – even though this is not the case.
The compounding of interest of the course of a year makes the APR seem inflated and for this reason, it appears to be a high number which is often over 1,000%.
Payday loans are different to regular loans
Payday loans are different to other types of high cost short term loans
in the way that they are only used for a few weeks or months maximum and are also designed to cover immediate emergencies and expenses, rather than a long-term financial commitment e.g. mortgages and credit cards.
With this in mind, you are not typically going to use a payday loan as an annual product and therefore should take this into account when comparing it to other financial products.
Understand the representative APR
Payday lenders are required to provide a representative APR and example when they present their loans to borrowers.
The representative refers to the rate offered to at least 51% of successfully funded customers. This means that you have a 49% chance of receiving a different rate and this might be higher or lower than the rate advertised based on things like your income, credit status and affordability.
If you have a good credit rating and low debt, it is possible that you could receive a rate lower
than the Representative APR advertised.
How to find the true cost of a payday loan
If APR is not a good measure for payday loans, then what is?
If you are truly looking to compare the cost of payday loans, you should look closely at the duration of the loan and compare it to borrowing other products for periods of 1,2 or 3 months.
In addition, you can look closely at the daily interest rate which according to the FCA price cap is 0.8% per day
. Since this is the rate charged by most lenders, anything below this would be considered to be cheaper.
You can look at other factors and features of the loans, such as those offered by Fund Ourselves. Fund Ourselves will never charge you the total interest more than the 100% of the loan value i.e., for you will never pay more than £100 interest on a £100 loan.
Not only are the cost of loans from Fund Ourselves less than the average payday lender, there are also no fees for applying and no early repayment fees.