Can Payday Loans Really Be Considered Expensive Compare to Other Short Term Lending Options?

When the press starts talking about payday loan advances, it is a rare occasion when the seemingly high representative APR is not mentioned. It appears that everyone is set on having a go at the payday loan companies calling them everything under the sun from loan sharks to out and out thieves. So are payday loans as bad as everyone tries to have you think they are?

It is a popular topic of discussion 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 arrive at the wrong conclusion. We are all conditioned to evaluate credit offerings by comparing the APR of financial products. However, this causes 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 amount of interest applied to the loan in a year. As most traditional loans run for terms of a year or more, 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 if you use an APR when comparing short term loans, the interest actually charged is grossly distorted.

An average payday lender has charges around £25 for every £100 borrowed for the agreed term of the loan. This means that if you borrow £200 for 28 days, you repay £250 when it is time to pay back 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, you want to know 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 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. They published an interim report on high-cost consumer credit, saying:

“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.”

Interestingly enough, 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 interest and charges levied on unauthorised overdrafts can have an 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 attract charges of £85.95. This is made up 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. What is frightening is that if you had gone overdrawn by a lesser amount, the same fee structure would apply with the result that the APR would have been even more monumental.
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 loans does not actually help the consumer, it is the actual charges being made by our high street banks that are the truly staggering numbers in the world of finance. Yet they are not required to display these charges as an APR, and often bury them in the small print so they are less obvious.

Britain’s banks currently charge 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 a huge source of revenue such as this.

So are payday loans too expensive? Well if your only other option is to go overdrawn without permission, then considering those costs, I hardly think so. Find out more about payday loan advances here.