PricewaterhouseCoopers (world’s largest accountancy firm) say's:
"In the case of payday lending an APR is fundamentally misleading."
APR is an acronym for Annual Percentage Rate or, simply put, it’s the interest plus any other additional fees or charges that you need to pay back on a loan and calculated over a period of year. A lot of times, you will also see lenders advertising their ‘representative APR’ which just means that percentage is the APR for the majority (at least 51%) of successful loan applicants. At this point, we will just stress the fact that APR is not just the interest you have to pay on a loan, but other factors like loan period, repayment method as well as the frequency, amount and timing of the loan installments are also a part of the number that you see.
All lenders are required, by law, to inform you what their APR is before you agree or sign any kind of contract with them. This is part of the UK Consumer Credit Act of 1974 requiring all types of lenders to clearly show their APR.
The actual formula for APR can be a little confusing, so we thought that the best way to demonstrate APR is to just give you an example. If you take out a loan for £1000 over a period of a year and you have to pay back a total of £1,200 in interest and fees, then the APR for that loan would be 20%. While that may seem fairly simple, it gets a tad more difficult when calculating the APR for short term loans, like payday loans, because they are meant to be paid back in a month or less, not a year.
So, here is an example of the APR of a payday loan compared to the APR of an installment loan – notice how the APR for a payday loan is skewed because of the shorter loan life, but the total amounts are nearly the same.
|Loan Type||Payday Loan||Installment Loan 1||Installment Loan 2|
|Loan Period||1 Month||36 Months||60 Months|
If you don’t want to take our word for it, because, let’s face it, we might not be the most objective source, let’s see what other financial experts have to say on the matter of APR and payday loans…
PricewaterhouseCoopers released a report in 2011, UK Consumer Credit In The Eye Of The Storm: Precious Plastic 2011 where they stated the following:
"In the case of payday lending an APR is fundamentally misleading. Annualising the interest cost of a product that is only offered as a short-term facility confuses the purpose of the loan and misrepresents the true cost. It’s similar to suggesting that the typical annual cost of a rental car might be close to £15,000, rather than a daily rate of £40. The total charge for credit may be a more beneficial measure for the consumer in this instance."
Another financial expert; Consumer Focus, conducted their own research in regards to the payday industry in 2010 and same to the following conclusion:
"Some borrowers like payday loans, despite the high interest rates, because they are quick, convenient and it is easy to understand how much it will cost them to repay the loan. Some consumers in the study chose them over mainstream borrowing from banks because they fear being hit by unexpected overdraft and credit card charges or that these credit options will tempt them into long-term debt. Indeed payday loans can be cheaper than running up an unauthorised overdraft."
The lesson to be learned here is that while APR can be a very useful tool when comparing two loans that are the same kind (like the two installment loans shown above), it’s not a practical tool for comparing all types of loans. It’s almost like comparing the costs of public transportation to the costs of a private cab.
If some person who had never taken a taxi or a bus before came to you and asked which mode of transportation was better, what would you say? Chances are, you would say that you can’t really compare the two because while one may enjoy significantly cheaper rates when traveling by bus, the convenience, ease and speed involved when taking a cab tends to balance the pricing scales. So, the same applies to payday loans… If you need money in a hurry and you don’t have time to wait for the bank’s approval or perhaps you’ve fallen behind on a prior loan and suffer from poor credit now, payday loans are a convenient and fast solution to a temporary problem.
It’s important to remember that in the same way one probably wouldn’t rely on taking taxis on a regular basis, one shouldn’t rely on payday loans either. Payday loans are only a temporary fix for an emergency or last-minute need and should only be taken out if one is 100% certain that they will be able to pay it back on the agreed upon date.
So, it is imperative to always borrow responsibly and to do any comparative research necessary to make sure that you are always getting the best deal on a loan. However, when dealing with short-term loans, perhaps APR just isn’t the best way to do it.
If you’ve decided, after carefully reading this and considering your current financial situation, that you would like to take out a payday loan, you can apply online right here. If you feel like your finances are out of control and you find yourself continually in debt on a monthly basis, look at our Debt Advice page where we have some very useful information on saving, budgeting and getting professional financial help.