Why Using APR to Compare Payday Loan Terms Can Be Misleading

The Annual Percentage Rate (or APR) turns a monthly interest rate into an annual rate to help borrowers compare different types of loans. Using APR can help determine which loan has a lower overall interest rate, especially when it contains a low introductory rate that rises after a certain amount of time. However, APR does not factor other loan terms, such as the length of time it takes to repay the loan. While it may make sense to use APR when comparing car loans or mortgages, it is misleading when applied to payday loans. Read on to find out why.

Why Payday Loans Show APR

Lenders are required by the Truth in Lending Act to disclose the loan’s interest rate to borrowers in the form of an APR. Payday loans fall under this requirement because they are classified as “short-term loans.” However, these types of loans are essentially cash advances with a fee. Other short-term loans can last up to 18 months, so using an APR might be applicable since it could take a year or more to repay that type of loan. Most payday loans, on the other hand, last just two weeks, so using an annual rate to analyze the loan is not a completely accurate depiction of the loan terms.

Another Way of Seeing Things

Most lenders view payday loan costs as a fee rather than a fixed interest rate. One industry insider likens using APR for payday loans to pricing meat at the grocery store by the ton, or parking meter costs by the year rather than by the hour. Unlike other loans, payday loans do not require long, drawn out payments, making it misleading to compare them as such.

Responsible Lending and Borrowing

While payday lenders continue to be required to provide an APR with each loan, they also show you the actual fee amount owed at the time the loan comes due. Consider using this number, along with the amount of time you have to repay, when comparing loans. While analyzing payday loans using APR may be the simplest method, informed borrowers also look at fees and repayment time to gain a broader picture of the true cost of their loan.

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