Everytime the media starts reporting on payday loan advances, it seldom happens that the seemingly high representative APR is not mentioned. It seems that everyone is set on having a go at the payday lenders calling them everything under the sun from loan sharks to out and out thieves. So is it all as bad as the media will have you believe?
It is a big talking point but for people who are not fully aware of how an APR (Annual Percentage Rate) actually works, which is most people, it is not difficult to arrive at the wrong conclusion. We have been conditioned to compare finance products by comparing the APR?s of each product. However, this creates a large problem when comparing short term loans.
Annual Percentage Rate was introduced to enable the comparison of interest rates on an annual basis and this is the cause of the problem. It is the amount of interest applied to the loan in a year. Because most conventional loans run for more than a year, using the APR as a comparison works fine. However, most payday loan advances are only designed to run over a short period of between 7 and 31 days. So if you use an APR when comparing short term loans, the interest actually charged is grossly distorted.
A typical payday loans lender charges around ?25 for every ?100 borrowed for the agreed term of the loan. What this means is that if you borrow ?200 for 28 days, when it is time to repay the loan, you repay ?250. This works out as an interest rate of 25%. Unbelievably, the APR has to be quoted as 1737%, which is bears little relation to what is actually correct.
So how relevant is the APR when it comes to payday loans? If you hire a car for a day, what you want to know is how much it is going to cost you. You are not in the least bit interested in how it will cost you ?14,600 for a year, you want to know that it is ?40 a day. As it happens, a lot of the payday lenders make the charges totally clear to borrowers upfront before they borrow the money. You will have it explained prior to borrowing the money that if you borrow ?200, it will cost you ?50 in charges, assuming that you pay back the loan on time. No other lending practice is that transparent.
So, the picture is totally distorted if you use an APR to compare payday loan advances. As it happens, the Office of Fair Trading support this viewpoint. They published an interim report on high-cost consumer credit, saying:
?Consumers appear to find the inclusion of the total repayment amount more helpful than an APR in understanding the cost of short-term credit. This may be due to the information distortion which results when an APR is applied to low sums over short periods.?
What is interesting is that, high street banks do not have to display their charges for overdrafts as an APR. I wonder what they would do if they did as unautherised overdrafts can attract charges and interest that amounts to APR in the millions!
If you bank with Lloyds TSB and go overdrawn for 10 days by ?200 without permission, you would pay ?85.95 in charges. This is made up of eight daily charges of ?10 for being overdrawn without permission, a ?5 ?usage fee? and 95p interest. These charges equate to an APR of 46,450,869%.
Lloyds dispute this by saying that the charges are capped at ?85 monthly. What is frightening is that if you had gone overdrawn by a lesser amount, the same fee structure would apply with the result that the APR would have been even more monumental.
With Santander, an unauthorised overdraft of ?200 could cost you ?60.68, an APR of 1,586,122%.
So although quoting the APR when it comes to payday loans does not actually help the consumer, it is the actual charges being made by our high street banks that are the truly staggering numbers in the world of finance. Yet they are not required to display these charges as an APR, and they are often buried in the small print so they often go unnoticed.
UK Banks currently charge up to ?20 a day on unauthorised overdrafts. It is only the fact that the banks recently won a high court battle, alongside the fact that there is no astronomical attention grabbing APR to publish, that allows them to get away with it.
Banks made an estimated ?2billion from charges such as these in 2009 so it is little wonder that they will fight to protect a huge source of revenue such as this.
So are payday loans too expensive? Well, if you have no other choice available other than to go overdrawn without permission, then considering those costs, I hardly think so. Find out more about payday loan advances here.
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