Everytime the media starts talking about payday loan advances, it is a rare occasion when 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 do not understand how an APR (Annual Percentage Rate) actually works, which is most people, it is not difficult to jump to the wrong conclusion. We have been taught to evaluate credit offerings by comparing the APR of financial products. However, this creates a large problem when evaluating short term loans.
The problem is that an APR was designed to compare interest rates on an annual basis, hence the name - Annual Percentage Rate. It is the rate of interest applied to a loan in a year. As most traditional loans run for terms of a year or more, using the APR to compare the loans works ok. 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 company will charge around £25 for every £100 borrowed for the agreed term of the loan. This means that if you borrow £200 for 28 days, when it is time to repay the loan, you repay £250. This translates as interest rate of 25%. This equates to an APR of around 1737%, which is totally misleading.
So is the APR irrelevant when it comes to payday loans? When 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. Most payday lenders make the costs of borrowing totally transparent and up front. 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. I cannot think of any other lending type that makes their charges so 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. When they published an interim report on high-cost consumer credit they said:
“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 express their charges for overdrafts as an APR. It would be interesting to see what would happen if they did as interest and charges levied on unauthorised overdrafts can have an APR in the millions!
If you bank with Lloyds TSB and go overdrawn for 10 days by £200 without permission, you would attract charges of £85.95. This consists 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. However, if you were to have gone overdrawn by a smaller amount, the same fee structure would apply making the APR even more astronomical.
For those that bank 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 loan advances does not actually help the consumer, it is the actual charges being forced upon us by our high street banks that are the truly staggering numbers in the world of finance. Yet they do not have to express these charges as an APR, and they are often buried in the small print so they are less obvious.
UK Banks are charging up to £20 a day on unauthorised overdrafts. It is only the fact that the banks recently won a high court battle, plus 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 small wonder that they will fight to protect such a huge source of revenue.
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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