You can do the math on a watch calculator, and it still doesn't add up. Image from Wikimedia Commons.
One of the claims you hear about payday lenders is that the APR charged for payday loans is more than 100 percent per year. Granted, there is a kernel of truth to it, but only if you happen to take one particular view. The supposed high interest is among the reasons that the financial reform bill calls for further restriction on payday lending. When thought about critically, it seems to be like hunting coyotes when Grizzly bears are the problem.
First, what is APR?
APR stands for Annual Percentage Rate. APR can be calculated in different ways, and standards differ between institutions and by regulations of any given country, but that is a different topic. The way the figures for the fees for payday lenders are calculated, according to prnewswire.com:
APR = [(interest rates or fees/amount being loaned) X (days of one year/the term of the contract)] X 100.
So, let us assume a person borrows $200 and is charged $15 in fees for a loan that is due in 14 days.
$15/$200 = 0.075
365 days/14 days = 26.0714
Now, we multiply those two figures:
0.075 X 26.0714 = 1.955
Multiply that by 100:
1.955 X 100 = 195.5 APR.
Now, the going assumption is that this APR rate would compound again and again were the loan to extend over the entire year, which it certainly does not. The loan is only for 14 days, not 365.
A truer picture of APR
If one were to take the view that the fee of $15 were to apply to every two weeks of the year, it would look like this:
$15 per every two weeks, and 52 weeks per calendar year. There are 26 two week periods per year, so:
$15 X 26 yearly two week periods = $390 total interest
Now if we were to divide the total interest by the principal:
$390/$200 = 195 percent.
Though 195 percent is right around the figures above, a person who borrows a cash advance or payday loan of $200 with a $15 fee certainly does not repay $390, they repay $215.
So looking the sum total:
$200 + $15 = $215
The difference in total paid, less the principal:
$215 – $200 = $15.
If we divide that over the principal:
$15/$200 = .075, or 7.5 percent. That doesn’t seem usurious to me.
Easier targets
Now, unlike payday loans, credit card interest always compounds monthly. Also, unlike payday loans, you don’t close a credit card two weeks after you open it. Thinking in those terms, are we sure that government should be regulating payday lenders with the financial reform bill before other forms of consumer credit?
Scot, you have a point, however 7.5% intrest on a $300 loan is hardly comparible to that of a mortgage. The reform bill wishes to place a 36% intrest cap which would be well over the tru APR for payday loans. Taking out a payday loan is a choice, no one is forces to do it. I have a problem when the Goverment tells me I have a legal right(choice) to murder my unborn child (abortion), however I do not have a right to take out a payday loan.
I wanted to point out a mistake in your math. You say:
“If we divide that over the principal:
$215/$200 = 1.075 percent, as the sum total of all interest and the principal. This doesn’t seem usurious to me.”
Actually, that 1.075 is not percent. It represents 107.5%. So, the interest one would pay would be 7.5%. That may not seem like a lot. But, that is, indeed, 7.5% over only a 2 week period. A typical home mortgage would be less than that rate for an entire year.
So, someone who habitually takes out these payday loans is paying a fairly large percentage (7.5%) just for the privilege of having their money 2 weeks early. That’s a WHOLE LOT different than having use of the money for an entire year.
Payday loans are horrible! That being said, it’s a free market, and nobody is forcing anyone to do this. Stupid is as stupid does. That goes for credit cards as well. Predatory lending? Sure. But, it’s a willing and voluntary prey.
Nice catch on the math error. All fixed!