Payday loans are expensive and no
one in the world doubts that. The APR rates for payday loans can be as high as
4200%, definitely signaling that someone is making a fortune out of them.
However, the APR rate does not show
the entire picture. Short-term lending is always expensive especially when the
amount is ridiculously small. Imagine running a business with just a couple of
employees. You will have to pay your employees, buy or rent a workplace, make
necessary payments to government agencies for regulating your business, and
spend money on advertising and marketing the business. With all these costs
adding up to the value of service of product, there is going to be $10 margin
for each unit to cover up the costs. The same thing happens when you borrow
$200 from a payday loan lender. The lender charging $10 for the amount borrowed
is actually paying for a place to work, for someone to process your loan, and
for someone to receive the payments. This is the bare minimal setup for a
payday loan lender, ignoring all the fees and marketing costs.
Suppose that you are paying $10 for
loan with repayment period set at two weeks. If $10 makes 5% of the amount
borrowed, annual charge (APR) will 130% without compounding. This seems massive
but you have to understand that the APR is for the same money rolled over 26
times.
In the previous example, we did not
add any interest. The 130% APR was only because of fixed fee charged for a loan
issued for two weeks. This is one of the major reasons that APR goes that high-
the fixed fee.
Usually people are confused since
they are used to bank loans. They see the APR in comparisons to bank loan
without considering the nature of both loans. Payday loans are personal loans
with a short-term commitment. Lenders will only lend a small amount, usually
one third of your pay. Due to this very nature of the payday loans, their
annual charge become gigantic despite the fact that these loans are not
expensive when viewed in the right time-frame and amount borrowed.
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