When people first look at payday loans, the first reaction is usually that the interest rates seem to be extremely high. Unfortunately many people don't change their mind about this, but what this article is going to explain is why they should. Which mainly comes down to understanding more about the APR attached to payday finance.
The APR
The APR, or Annual Percentage Rate, is a useful measuring tool for long term loans. It tells you how much interest you are going to have to pay in a year, and this is useful a lot of the time because people think of the amount of money they have in terms of how much they make in a year. However it's not useful for payday loans.
All you have to know about payday finance to realise that the APR is not a good way of judging the interest rates charged by payday lenders is that the loan is generally only supposed to last a month. All you are being told by the APR, therefore, is how much interest you are going to be charged if it takes you fully 12 times longer to repay than you have agreed on.
It is really necessary to tell people that if you take 12 times longer to repay a loan than you are supposed to that the interest rates are going to be very high? If they did, why don't loans that last 3 years have the rate for repaying in 36 years printed to them? That is the precise equivalent of judging a payday loan by the APR, so clearly it is not useful at all.
The Actual Interest Charged
What this should have demonstrated then is the ridiculousness of judging payday loans simply by the APR that is attached to them. They are such short term loans that it doesn't really matter. The real interest rate you can discover by asking how much you are going to be charged overall, and then the discovery is that you are usually only being charged around 25% to 30%. So a lot less than the APR.
Now, even this rate might seem as if it is expensive if you are going to judge long term loans by their APR. Remember though, if the loan lasts for more than a year, then the amount of interest that you are actually going to have to pay is going to be more than that. And the figure given for a pay day loan is the total amount that you are going to have to pay. It makes sense to compare these figures directly then.
There is another reason that using the APR to judge loans is popular with long term lenders, which is that it means that people pay less attention to how much interest they are being charged overall. To take a simple example then, let's say that you take out a loan for 5 years, with a reasonable APR of 17%. After 5 years you will have paid almost as much in interest as you took out in the form of a loan, that is it is almost 100% interest.
When you need a large sum of money which you pay back over a long time period of course, the long term loan is still going to be best for that. What all of this really goes to show is that comparing short term loans and long term loans is not really fair, as they are used in entirely different situations. Next time you look at the APR on a payday loan then, just remember that the actual amount of interest you'll be charged is going to be a lot less than that.
The APR
The APR, or Annual Percentage Rate, is a useful measuring tool for long term loans. It tells you how much interest you are going to have to pay in a year, and this is useful a lot of the time because people think of the amount of money they have in terms of how much they make in a year. However it's not useful for payday loans.
All you have to know about payday finance to realise that the APR is not a good way of judging the interest rates charged by payday lenders is that the loan is generally only supposed to last a month. All you are being told by the APR, therefore, is how much interest you are going to be charged if it takes you fully 12 times longer to repay than you have agreed on.
It is really necessary to tell people that if you take 12 times longer to repay a loan than you are supposed to that the interest rates are going to be very high? If they did, why don't loans that last 3 years have the rate for repaying in 36 years printed to them? That is the precise equivalent of judging a payday loan by the APR, so clearly it is not useful at all.
The Actual Interest Charged
What this should have demonstrated then is the ridiculousness of judging payday loans simply by the APR that is attached to them. They are such short term loans that it doesn't really matter. The real interest rate you can discover by asking how much you are going to be charged overall, and then the discovery is that you are usually only being charged around 25% to 30%. So a lot less than the APR.
Now, even this rate might seem as if it is expensive if you are going to judge long term loans by their APR. Remember though, if the loan lasts for more than a year, then the amount of interest that you are actually going to have to pay is going to be more than that. And the figure given for a pay day loan is the total amount that you are going to have to pay. It makes sense to compare these figures directly then.
There is another reason that using the APR to judge loans is popular with long term lenders, which is that it means that people pay less attention to how much interest they are being charged overall. To take a simple example then, let's say that you take out a loan for 5 years, with a reasonable APR of 17%. After 5 years you will have paid almost as much in interest as you took out in the form of a loan, that is it is almost 100% interest.
When you need a large sum of money which you pay back over a long time period of course, the long term loan is still going to be best for that. What all of this really goes to show is that comparing short term loans and long term loans is not really fair, as they are used in entirely different situations. Next time you look at the APR on a payday loan then, just remember that the actual amount of interest you'll be charged is going to be a lot less than that.
About the Author:
Gabriel Ward has expertise in all different financial affairs. He very much enjoys writing regularly at Payday loans a place you can discover much more about payday finance.
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