Unless you have been living under a
rock for the past year you will have noticed the rush of companies that are
fighting to offer you a short term loan. Usually called payday loans, these
lending solutions provide extremely short term loans for people that need a top
up to get them through to the end of the month. The loan terms are usually 1
month but they could be as short as two days or as long as three months.
Are payday loans a bad thing?
The short term loan providers have
come under intense criticism, some of it justified and some not. The main
criticism has been because of the apparently massive interest rates they
charge. There is no doubt that payday loans can be a dangerous thing if the
customer doesn't understand them but the incredibly high representative APR
values that are quoted are really not a true reflection of what you are
actually going to pay.
You have to realise that these
payday loans are only a short term solution. If you rigidly stick to the terms
and conditions of the loan and pay back the amount you borrow and in the agreed
timeframe then you will typically pay around 1% per day. The key is to pay the
loan back on time, if you can't pay back on time then you should contact the
lender as soon as possible because you will likely pay charges if you fail to
pay back within the agreed time frame.
So why is the representative APR so
high?
The representative APR is a figure
that is used to compare loans and other banking products. It is a
representative figure that shows the interest you would pay if your loan term
was a single year. Representative APR values of short term loans are typically
in the thousands of percent range. This looks like an incredibly high and scary
number when you compare it to the relatively low values stated by credit cards
or a standard unsecured loan but really the representative APR value of a
payday loan is a completely nonsense value. It is only useful to compare the
short term loans against each other.
You will never, ever pay 5000% on
your payday loan even though the representative APR is shown to be 5000%. The
loan term is never going to be anywhere near a year, it will more likely be one
month. The representative APR that is stated is calculated by scaling the daily
percentage up to a year and showing you what you would pay back if that same
loan was paid back over the period of a year.
Show me an example!
The example below shows how a
representative APR of 5000% equates to a much lower pay back than expected if
the loan term is 30 days.
Day rate % = (representative
APR/365) * (loan term/365)
Day rate % = (5000/365) * (30/365)
Day rate % = 1.13%
Day rate % = (5000/365) * (30/365)
Day rate % = 1.13%
Say for example you borrowed $100.
You wanted to pay back your $100 over one month or 30 days. So over the 30 day
period you would pay back your $100 plus 1.13% per day. You would pay back a
total of $133.90 spread over the month, roughly $33.50 per week. There are also
usually admin charges on top of this as well so you would pay back slightly
more but I am keeping the numbers simple!
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