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).

An example…

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…

Here’s how that’s figured:

APR = i × (365 ÷ n)

where…

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%

OUCH!

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:

ATM fees
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.

### 19 responses to Just How Expensive is a Payday Loan?

1. I am going to have to side with the CFSA on this one. If I bounce a check, I am going to have to pay \$39. \$25 is the highest I have ever heard for a \$100 pay day loan. I took out one payday loan myself for a mystery shop that I did, and it was \$20. I would ration pay \$20 than \$39 any day. Beyond that, it is a mark on your ChexSystems report.

In either case, it is typically irresponsible to get yourself in the position where you need to resort to such measures. Sometimes people have a rough spout, and they need some help; other times, people are just irresponsible and they are the type that will get stuck in the payday loan cycle.

2. I am actually surprised they didn’t use an average ATM withdrawal amount. I would daresay the average withdrawal is far less than \$100 which would drastically increase the ATM fee APR.

Having said that, I think they are abusive. I also think the same thing of banks who charge multiple NSF fees on multiple overdrafts.

3. There is some truth in what CFSA states, though. As Dus10 wrote, comparing the late fees and bounced check fees the banks would charge if you had gotten yourself into that situation, a payday loan doesn’t seem that bad. Really, this is the market that payday loan is operating under. However, much we want to cry foul on payday loan, they are really no worse than banks with high fees and high interest rates. Banks made record profits because of these fees and interest rates, but no one has mustered up the complaints as they do with payday loan companies. I think both are terrible, and hopefully people will realize that it is simply not worth the extra expense to get yourself into a situation where you have NSF or are going to be late.

4. Those loans should be illegal. You cannot feel comfortable or sleep at night knowing you are ripping people off.

Those are the worst loans ever created.

5. I agree with the other posters, that the comparison between a payday loan (similar to loansharking) and bank service charges (similar to extortion or thievery) makes the payday loan look great.

Payday loans suck compared to a mortgage, but nobody finances their house with a payday loan. I would have to grudgingly admit that payday loans serve a purpose. If consumers get in trouble then it is really their own fault. That said, the targets of payday loans are clearly those who are closer to being broke and probably have bad financial skills, namely those who have lower defenses against payday loan marketing.

Opportunistic, but there is lots of competition and lots of demand so, to me, they are not doing much wrong. People who use payday loans have problems that weren’t caused by the payday loan company.

6. Great post! I must have missed this one. I have you on my blog reader to read your updates, just need to go through your archives more thoroughly. Your blog is one of my favorites!

7. Your math is good, but it might be the wrong measure for a payday loan.

Example: Suppose I see a penny lying on the ground. If I don’t spend the 1 second that it takes to pick up the penny then that decision, by extending the math costs me the per-second rate of over \$850 per day or \$315,000 per year! In the end it’s only a penny and it isn’t worth my effort to pick it up and carry it.

If \$25 on a hundred dollar payday advance is worth it, then so be it. To us, who reference a different kind of loan, it’s a huge amount. We would never get a mortgage or car loan at 600% and we don’t make 600% on our mutual funds. But do you pick up the penny or do you not need an extra \$315K per year?

8. CustomersRevenge is absolutely right.

And of course let’s not forget those thieves at the hamburger stores who cook a hamburger with ingredients that cost one dollar and then charge us THREE DOLLARS for that same hamburger! That’s a 200% markup for a measley hamburger.

My point is that the payday stores aren’t just raking in pure profit. They have to pay rent, they have to pay someone to stand behind the counter, security, insurance, utilities, taxes, defaults by the highest risk borrowers. And at the end of the day they walk away with only \$15 per transaction. Big banks can charge lower rates for secured loans to better credits because they are much larger dollar amounts. A 1% spread on a \$500,000 mortgage is \$500 per year. It’s a lot easier to pay the overhead on \$5000 transactions than \$15 transactions. If anyone thinks payday lenders are making outsized profits, there is nothing stopping them from opening up their own store across the street and charging less. That’s the free market.

9. I see that the math for calculating APRs on single loans is simple. Could you provide an example of a loan rolled over 3 or 4 times?

Thanks.

10. J. Crenshaw asked about the math on loans that are rolled over. It’s ugly, very ugly. You have a loan here that is compounded biweekly with a 25% interest rate for that period. If you calculate the compounded interest rate for that for an entire year, the math is:

APR = (1 + i)(365 / 14) – 1

In case the HTML for the superscript doesn’t come through the comment filters right, that’s 1.25 to the power of (365 / 14) minus 1.

That’s 336.18. It looks even scarier when you shift the decimal point 2 places to the right to get a percentage. Yes, that comes to 33618% APR when it is compounded. Assuming the victim isn’t cut off long before that, he could borrow \$100 to get his car fixed and find himself owing \$33,618 a year later.

More realistically would be rolling the loan over 3-4 times before he’s cut off. Let’s say 4 times. After 8 weeks, the balance on the loan will be \$244. If the pay day loan people decide that they can risk that \$244, they can always let him go another 8 weeks, by which time the balance will have grown to \$596.

11. Hi Dale:

In the formula on question 16, should you divide the rate the same # as the power (365/14) and should the power be a negative #?

Thanks.

12. ===============================================
Humorist Will Rogers said, “All I know is what I read in the newspapers.” If that’s all you know, you won’t know that “return on innvestment” is thousands of percent per year in the “payday loan” industry. (Proving that is a trivial exercise; contact “loanmath33@yahoo.com”.)

The terms, “interest rate”, “cost of borrowing”, “return on investment”, and “time-value of money” were coined and defined by money-“lenders”; in any “loan” transaction, their values are equal. (For proof of that, see any textbook on bona-fide “loan”-math; titles are available
from “loanmath33@yahoo.com”.)

Mankind has long known how to do “loan”-math;
grifters and their lackeys have long known how to deceive those ignorant of it.

If the fortnightly “payday loan fee” is \$9.66 per \$100 or more, alleging “annual interest rate” to be less than 1,000 percent per year demonstrates either abysmal ignorance or a desire to deceive.
===============================================

13. Great Article. In Colorado, I have seen payday loans with interest rates in excess of 1500%APR. I have also had clients who had to take bankruptcy, not because of larger credit card debts, but because of payday loans.

14. I suggest taking all that research and comments to a person in need and see what the will tell you. I guess for the people that have lots of money is easier to blame the payday loan companies comment on how easy is to save with the prices on everything these days. There will always be money problems and different options, payday loans included on those… How about letting people decide by themselves? Comments like such demand that the commenter gets out on the streets and starts building that better option for people with small cash need.

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