Pay day Loans and APR
Annual Percentage Rates (APR) are a way of calculating costs of a loan if it were extended for a year. Because payday loans are only designed for a short amount of time, they end up looking far more expensive than they actually are.
On a payday loan fast, you usually pay around £25 per £100 over a 28 day period. This isn't designed to be taken out for a longer period, since it's a short term solution.
It's all about the time the loan is taken out for. If you took out a £100 loan, and paid £25 after a year (rather than a month), the APR would be more along the lines of 25%.
Here at Payday Bank, we have no problems making the loan rates as clear as possible. After all, we think we make it possible for customers to get great deals when they need payday loans fast, and we want to be clear about them. But is APR the best way to do it?This can be highly confusing for customers. As part of our agreement to abide by the regulations enforced by the Office of Fair Trading, we are obliged to display this information prominently along with any information about the loans that are offered. When we describe the rates on payday loans, the representative APR that we show alongside them is often four figures. This can be a little frightening at first glance. The reason for this is because APR is designed to measure a completely different kind of loan.
Perhaps we'd better start by explaining what an APR actually is. It's what percentage needs to be paid back on the loan if these were the rates for 12 months, assuming compound interest is used. As a result of this, the...Hang on. It's probably worth explaining what 'compound interest' is, isn't it? It's one of those terms that you hear all the time, but nobody ever actually explains how it works. Basically, let's say that you take out a payday advance of £100, agreeing to pay back a one off payment of £125. The interest rate is 25%, right?
Not quite. If you can't pay it back that month, the interest needs to be paid again – another £25. This means that the interest goes from 25% to 50% on the original loan and the total amount owed is £150. This is one of the reasons we encourage you to be sure you can pay back on time. However, if we were to use compound interest (which we don't), that would mean paying back 25% on the £125, rather than the £100. This means that you'd now pay £156.25. The following month, you'd pay 25% of THAT, leading to £195.31 (rather than £175 without compound interest).
Do that 12 times, and it adds up very quickly. Get a calculator and work it out yourself – just multiple 100 by 1.25 12 times. That's how compound interest works. We don't offer the ability to apply for short term loans for that long, and on top of that, short term loans don't use compound interest.So we're aware that it's a little bit confusing that we're obliged to show the rate as if the short term loans were all for a year and use compound interest. However, whenever we do, we always make it nice and clear how much you can expect to actually pay.
It won't be exact – loan amounts vary from customer to customer – but it won't vary much from that. Whenever you take out a payday loan, you can expect to pay roughly £25 per £100 borrowed.
Just take out your payday advance, and pay back around 25% interest when you get paid. How much simpler is that to work out than the compound interest?
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