Banks and most mainstream lenders use APR (annual percentage rate) as measuring stick to compare their different loans. APR is a way of calculating the amount of interest you pay on a loan over the course of one year.
Smaller loans have shorter repayment windows and higher APR, while large loans like mortgages have much lower APR, with perhaps 20 years as a repayment window.
But there are almost no mainstream banks or lenders that offer the small loans many people rely on. Even the small “personal” or “signature” loan at a bank will be for several thousand dollars. Not only are they hidden behind a maze of red tape, but for many borrowers it is just too much money. Even if they had the credit rating to be approved for $5000, they don’t want that much.
That is where payday lenders come in. Cash advances, or payday loans, are micro-loans of $100 to $500, designed to be almost immediately repaid.
As part of an ongoing smear campaign, mainstream banks attack payday lenders for their high range of APR, while ignoring one key fact: payday lenders don’t base their business on APR like banks do. It’s apples and oranges.
For a payday loan, you pay a fee for the amount of money you borrow (usually 25% of the borrowed sum). APR doesn’t apply because these loans are for small amounts with small repayment windows – a typical payday loan is for a few days, up to as long as a month. As they are based around the borrowers pay schedule, they become due on the customer’s next payday.
` Thusly, when a payday lender is attacked for having “1000% APR” it is misleading. In truth, they paid a 25% fee for the loan. If by some chance they do not pay that loan back for a year, then yes, they will have paid a large amount of money to repay a very small loan. But it still isn’t “1000% APR” its “repeated payment of the same fee because they did not repay the loan when they agreed to do so.”
A perfect example of this principle is found at the Redbox movie rental kiosks.
You pick out a movie, select it, and swipe your card. You have agreed to rent this movie for $1.25 per night. If you do not return the movie within 24 hours, you are billed another $1.25.
You keep the movie for 10 days, return it, and then claim “the Redbox charged me $12.50 to rent a movie.” Of course it didn’t – they charged you $1.25 per rental, and you simply did not return the movie.
If you keep the movie for 30 days, you will have paid $37.50 for a rental. Which is a ridiculous number, but also isn’t accurate of the typical Redbox transaction, which costs… yep… $1.25.
And so it goes with payday loans. The typical payday loan transaction is for a small amount, and repaid quickly for that same amount plus 25%. It’s not 1000% interest, never has been, never will be.