How important is a payday loan’s APR?
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UPDATED: Nov 7, 2011
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When borrowers begin searching for a payday loan, they usually do not see any percentage rates in the advertisements. It is not uncommon for payday loan websites and stores to express a loan’s costs anecdotally, using dollar amounts for consumers to gauge what they will owe.
For example, a payday loan site may say they will lend $100 for a $15 fee come the borrower’s next paycheck. This is effectively a 15 percent interest rate on the money borrowed; however, that 15 percent interest rate is charged between obtaining the loan and the borrower’s next paycheck. It represents the payday loan’s term rate.
A term rate is the rate of interest charged over a certain time period. With payday loans, the term rate is two weeks: the time it takes borrowers to acquire their next paycheck.
There is another way to measure interest rates, which is required to be on all loan statements in the United States: the annual percentage rate (APR). In most cases, a loan’s APR is a more accurate way to determine the true cost of a loan. The APR shows what the interest on a loan will be, with all fees included, over the course of one year.
The APR is important to consider when deciding what payday loan to acquire because it gives borrowers a realistic depiction of what they will owe when compared to other forms of credit.
A payday loan’s APR sheds light on the misleading term rate. For instance, a payday loan with a 15 percent, two-week term effectively has an APR of 390 percent (15 percent times 26 two-week terms in one year).