How do the APRs on payday loans get to be so high?

Payday loans come with astronomically high annual percentage rates (APRs) that can reach 400% or more. This is largely due to their short-term nature and high fees relative to the loan amount.

While a $15 fee on a $100 two-week loan may not seem like much, it translates to an APR of nearly 400% when annualized.

Keep reading to understand better the universe of payday loans, including topics such as the structure of APRs, how to calculate payday loans APR rates, tips to get lower APR payday loans, and much more.

What is a Payday Loan

To better understand its APRs, is important to know what is a payday loan. They are are short-term, high-cost loans designed to be repaid on your next payday, what means within 2-4 weeks. Here’s how they work.

• You need quick cash, usually $500 or less.
• You write a post-dated check or authorize an electronic withdrawal for the loan amount plus fees.
• The lender gives you cash immediately.
• On your next payday, the lender cashes your check or withdraws the money electronically.

The real trouble starts when payday arrives and you can’t repay the loan in full. Many borrowers end up taking out another loan or rolling over the current one. This can quickly turn into a debt cycle, where you’re constantly borrowing to cover your previous loans.

Understanding the APR in payday loans

Okay, now we know what is a payday loan, so we can move forward and comprehend the APR itself.

The Annual Percentage Rate (APR) represents the true cost of borrowing money over a year. For payday loans, the APR is typically in the triple digits, often ranging from 300% to over 600%.

Let’s compare payday loans APRs to other forms of credit:

As you can see, payday loans are significantly more expensive than other credit options. They can be 20 times more expensive than personal loans, the second highest APR on this table.

How to Calculate Payday Loans APR Rates

Ever wondered how those sky-high payday loan rates are actually calculated? Let’s break it down in simple terms.

First, you need to know three key pieces of information:

1. The amount you’re borrowing
2. The fee you’re being charged
3. The length of the loan term

Now, here’s the formula:

APR = (Fee / Loan Amount) x (Number of Days in a Year / Loan Term in Days) x 100

For instance, let’s say you’re borrowing $300 for 14 days with a $45 fee.

APR = ($45 / $300) x (365 / 14) x 100 = 391.07%

That’s means you have a 391.07% APR in a two-week loan. But wait, it gets worse. Many people can’t pay back the loan in two weeks and end up rolling it over. Let’s say if you have rolled over that loan for three months. The APR stays the same, it’s in the contract, but you’ve now paid $270 in fees on a $300 loan.

That’s why we always need to consider alternatives like personal loans, credit union loans, or negotiating with creditors before turning to payday loans.

On the other hand, payday loans are fast cash. So, if you really need urgent money and are sure you can repay them, they can be an option.

State Laws That Control Payday Loan Interest Rates

When it comes to payday loan interest rates, not all states are created equal. In fact, the rules can vary wildly depending on where you live.

Some states have maximum legal APR for payday loans. For example, Colorado limits it to 129%. That’s still high, but it’s a far cry from the 664% you might see in Texas!

However, other states don’t have any limits at all. In these places, lenders can charge whatever they want. Here’s a quick breakdown of how states handle payday loan rates:

1. 18 states plus D.C. have effectively banned payday loans by capping rates at 36% or lower.
2. 32 states allow payday lending with varying degrees of regulation.
3. 6 states have no rate cap at all.

You can check the maximum legal APR for payday loans in your state on the National Conference of State Legislatures website.

It’s worth noting that even in states with rate caps, payday lenders often find loopholes. They might offer products that technically aren’t “payday loans” to skirt the rules.

The bottom line? Don’t assume your state is protecting you from sky-high rates, even with maximum legal APR for payday loans. Always do your homework and calculate the APR before signing on the dotted line.

Tips To Get Lower APR Payday Loans

While payday loans are notorious for their high APRs, there are ways to potentially lower your costs. Here are some tips to help you secure a more affordable payday loan.

Use Financer’s Loan Finder Tool

The best way to find lower APR payday loans is to use Financer’s Loan Finder tool. This free tool allows you to compare multiple lenders side by side, making it easy to spot the best deals.

By using the Loan Finder, you can save both time and money. Instead of applying to multiple lenders individually, you can see all your options in one place.

Improve Your Credit Score

Your credit score plays a big role in determining your loan terms. While many payday lenders don’t check credit, some do, and a better score can lead to better rates.

Start by checking your credit report for errors and disputing any inaccuracies. Then, focus on paying bills on time and reducing your credit utilization. Even a small improvement in your credit score can lead to significant savings on loan interest.

Borrow Only What You Need

The more you borrow, the more you’ll pay in interest and fees. Always borrow only what you absolutely need, not what the lender offers.

Make a budget to determine the minimum amount you need to cover your emergency expenses. Borrowing even $50 less can make a significant difference in the total cost of your loan.

Consider a Credit Union Payday Alternative Loan (PAL)

Credit unions offer Payday Alternative Loans (PALs) that cap interest rates at 28% APR. That’s a far cry from the typical payday loan rates that can reach 400% or more.

To qualify for a PAL, you’ll need to be a member of a credit union. However, many credit unions have relaxed their membership requirements, making it easier than ever to join.

Negotiate with the Lender

Don’t be afraid to negotiate with payday lenders. While they may not budge on their standard rates, some may be willing to lower fees or extend repayment terms, which can effectively lower your APR.

Remember, lenders want your business. If you’ve found a better offer elsewhere, let them know. They might be willing to match or beat it to keep you as a customer.

Alternatives to High APR Payday Loans

Before you commit to a high-cost payday loan, consider these alternatives that could save you a bundle.

Personal Loans

With APRs typically ranging from 6% to 36%, personal loans are often much cheaper than payday loans. They also offer longer repayment terms, making them easier to manage.

Credit Card Cash Advances

While not ideal, credit card cash advances usually have lower APRs than payday loans. Just be sure to pay it back as quickly as possible to minimize interest charges.

Payday Alternative Loans (PALs)

As mentioned earlier, credit unions offer these as a safer alternative to payday loans. PALs cap interest rates at 28% APR and give you up to 12 months to repay.

Borrowing from Friends or Family

This can be tricky, but is often the cheapest option. Just be sure to treat it like a formal loan with clear terms to avoid damaging relationships.

According to the Pew Charitable Trusts, the average payday loan borrower spends $520 in fees to repeatedly borrow $375. By exploring alternatives and using tools like Financer’s Loan Finder, you can avoid this debt trap and keep more money in your pocket.

Always compare your options before committing to any loan. With Financer’s Loan Finder, you can quickly see which lenders offer the best rates and terms for your situation. Don’t let a financial emergency push you into a costly payday loan when better alternatives are just a click away.