Two words: VERY EXPENSIVE!
The typical payday loan is a two-week loan. The fee for such a loan is $15 to $25 per $100 borrowed (that’s for TWO WEEKS).
Let’s say times are tough and Jack needs $100 to fix his car. Jack goes down to the local payday loan company and they agree to give him a loan. So Jack writes a check for $125 and gives it to the payday company and they give him $100. Two weeks later, Jack gets paid and the payday loan company cashes Jack’s check, closing out the deal.
Now, take a wild guess as to how much the APR (Annual Percentage Rate) is on Jack’s loan…
How about 651.79%!
Here’s how that’s figured:
APR = i × (365 ÷ n)
i = periodic interest rate, which is 25% in this example ($25 fee ÷ $100 = .25 or 25%)
n = time period of the loan, in this case 14 days
Filling in the numbers, our formula looks like this:
APR = .25 × (365 ÷ 14)
APR = .25 × 26.0714
APR = 6.5179 or 651.79%
One thing I find kind of humorous is that the The Community Financial Services Association of America (CFSA), the trade group that represents most payday lenders, has a chart on their website comparing different APRs for various “alternatives” for payday customers. Things like:
Late fees on credit cards
NSF fees on checks (both at the bank and at the merchant)
They claim that when put an APR on these fees, a payday loan doesn’t look so bad. It’s almost laughable what they are trying to do. From the CFSA website:
In SOME CASES a payday loan MAY be the lesser of two evils particularly if it not getting a loan means missing a credit card payment or bouncing a check. However, if times are tough how are you going to be sure you can pay the payday loan back? If you can’t you will have to get another loan and will be charged another 25% on the amount borrowed. This is how people get into trouble with payday loans.
The best thing to do is build up a float in your savings account so that you don’t end up with a shortfall due to an unexpected expense. In a lot of cases a payday loan is only going to make matters worse.
Oh, and in case you haven’t seen it yet, the CFSA is trying to win over the hearts of Americans with this commercial.