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Are Payday loan Advances Really Too Expensive Compared to Other Short Term Finance Facilites?
When the press starts talking about payday loan advances, it seldom happens that the seemingly high representative APR is not mentioned. It appears that the entire media is out to have a go at the payday loan companies 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 are not fully aware of how an APR (Annual Percentage Rate) actually works, which is most people, it is very easy to draw the wrong conclusion. We are all conditioned to compare finance products by comparing the APR’s of each product. However, this creates a huge problem when comparing short term loans.
Annual Percentage Rate was introduced to enable the comparison of interest rates on an annual basis and this is the cause of the problem. It is the rate of interest applied to a loan in a year. Because most conventional loans run for more than a year, using the APR as a comparison works fine. Payday loan advances on the other hand, only run for a term of around 7 – 31 days. So by using an APR to describe payday loan charges, you grossly distort the actual figures.
An average payday loans company charges around £25 for every £100 borrowed for the agreed term of the loan. What this means is that if you borrow £200 for 28 days, you will pay back £250 when it becomes time to repay the loan. This works out as an interest rate of 25%. Yet the APR is around the 1737% mark, which is bears little relation to what is actually correct.
So how relevant is the APR 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 know before you take out the loan that if you borrow £200, it is going to cost you around £50 in interest charges provided that you pay back the loan at the agreed time. No other lending practice is that transparent.
So using an APR to compare payday loan advances gives a totally distorted picture. This view is also supported by the OFT. 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 display their charges for overdrafts as an APR. It would be interesting to see what would happen if they did as unautherised overdrafts can attract charges and interest that amounts to APR in the millions!
If you were to go overdrawn for 10 days without permission by £200 and you bank with Lloyds TSB, you would pay £85.95 in charges. 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.
With Santander, an unauthorised overdraft of £200 could cost you £60.68, an APR of 1,586,122%.
So whilst quoting the APR is not actually helping the consumer when it comes to payday loans, what is more scary is the actual charges being made by our high street banks that are the truly staggering numbers in the world of finance. Yet they do not have to display 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, alongside the fact that 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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