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Just How Expensive is a Payday Loan?
By JLP | February 25, 2007
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…
How about 651.79%!
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.
Topics: Budgeting, Credit, Miscellaneous |
February 26th, 2007 at 8:23 am
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.
February 26th, 2007 at 9:04 am
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.
February 26th, 2007 at 9:42 am
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.
February 26th, 2007 at 11:02 am
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.
February 26th, 2007 at 1:13 pm
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.
February 26th, 2007 at 1:56 pm
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!
February 26th, 2007 at 3:07 pm
[…] If people knew the true cost of a payday loan, perhaps the industry wouldn’t be growing like cancer. AllFinancialMatters breaks down the math. […]
February 26th, 2007 at 6:17 pm
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?
February 27th, 2007 at 8:29 am
[…] Just how expensive is a payday loan - Payday loan companies grow like weeds and you pay an interest rate of over 600%. […]
February 27th, 2007 at 9:20 am
[…] Payday Loan Math from JLP at All Financial Matters. […]
February 28th, 2007 at 3:10 pm
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.
March 2nd, 2007 at 5:21 am
Star Money Articles for the Week of Feb. 26
Here are interesting posts and news this week from the MoneyBlogNetwork members and beyond: MightyBargainHunter asks if it’s time to sell your house and rent. Five Cent Nickel tells how to profit from 0% balance transfer credit card offers. Blueprint
March 5th, 2007 at 5:27 pm
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.
March 6th, 2007 at 3:42 am
The above article with regard to payday loans
is quite interesting & providing valuable information along with statistical figures.I have seen similar web pages which is providing adequate information……………
March 6th, 2007 at 8:50 am
[…] Payday Loan Math […]
March 8th, 2007 at 11:16 am
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.
March 20th, 2007 at 11:02 am
PR Blitz Can’t Make Payday Loan a Good Deal
The Torrance Daily Breeze ran an article March 11, 2007 discussing the recent decision by The Community Financial Services Association of America to spend $10 million for an advertising campaign to educate payday loan users on responsible borrowing.
Jean Ann Fox, director of consumer protection for the Consumer Federation of America says, “This is a public-relations act from an industry under heavy fire. This move is to derail state and congressional legislation.”
Don Gayhardt, president of Dollar Financial, said, “If it only cost $10 to bounce a check, I’m not sure we would have nearly as big a payday loan industry.”
Clearly payday loans can be very dangerous to your financial well being. Ms. Fox’s mission seems to be to help educate consumers so they can make an informed choice.
Is there a place for payday loans? I can see certain circumstances where an online payday loan really is your last and only resort.
If you take a fast cash loan, please only borrow what you will be able to pay back when you get paid from your job.
Rolling existing payday loans can be a disaster financially. Please always borrow responsibly.
March 24th, 2007 at 1:23 pm
[…] They are extremely expensive and addictive. […]
April 24th, 2007 at 9:56 am
[…] I’m pretty sure I have made my stance clear on payday loans. They’re expensive and I hate ‘em. That said, I do take issue with an editorial (pdf) I read today in my local paper. The piece was written by Don Baylor who is a senior policy analyst at the Center for Public Policy Priorities. Here’s the part of his editorial that bugs me: Nationwide, many workers are falling victim to “payday” loans—short-term loans that give workers a cash advance on their paychecks. Large numbers of military families use these loans to help make ends meet between pay periods. So do millions of low- and middle-income people across the country. The problem is that these loans come with a major catch—exorbitant interest rates that begin at 400 percent Annual Percentage Rate (APR) and can surpass 1,000%. […]
April 27th, 2007 at 12:46 am
Personally, I totally agree with you.
May 5th, 2007 at 3:32 pm
mainstream media, the military, Congress, federal and state regulators, community groups, and the plaintiffs bar – just to name a few.
Yet, few deny the demand for small dollar lending. Unfortunately, banks and credit unions have yet to put forth a less expensive product that also competes when it comes to convenience, approachability, privacy, and simplicity.
We developed the RevelCard as a means to bring consumers an affordable payday loan alternative. The RevelCard’s “Bank on a Card” objective delivers all the common services expected at a typical bank branch through nonbank, alternative delivery channels – meeting the consumer on his/her terms and where he/she feels comfortable conducting their financial business. Features include:
• A low cost transaction account accessed through a prepaid MasterCard
• Full online banking capabilities, including bill payment and money transfers
• RevelAdvance – a small dollar loan feature 40-60% less than a payday loan
• RevelSave – an integrated savings account
• RevelSpendTrend – online budgeting and expense tracking
Check out the first scalable banking alternative to payday lending at http://underbanked.blogspot.com and http://www.revelcard.com.
June 27th, 2007 at 6:51 am
Payday loans have only recently started to become mainstream in the UK and one advert on TV caught my attention because the company offers payday loans with a typical APR of 2339.30%!!
The cost of borrowing £250 for 30 days is £75. That’s 30% of the original loan value in just 30 days!!
Defer the loan and the interest just gets stupid(er)…!?
October 31st, 2007 at 5:51 pm
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.
November 21st, 2007 at 10:39 am
===============================================
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.
===============================================
April 15th, 2008 at 1:27 pm
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.