Why is APR a bad measurement for payday loans?

Why is APR a bad measurement for payday loans?

Imagine you’re back at school or college and you’re looking for a job for a few weeks over the summer holidays to pay for a holiday. You need to earn £500 but all the jobs advertised are only showing their annual salary, which makes it hard to compare which job is right for you. This is similar to how APR works for payday loans. It’s simply not a useful measurement for borrowers to use. Here, we explain why.

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What is an APR?

The APR, or annual percentage rate, is a measurement that the Financial Conduct Authority (FCA) requires all lenders to advertise in order to help people compare the cost of borrowing between providers. The annual percentage rate shows you what the loan costs you over an entire year of borrowing – including all fees, charges and interest – presented as a percentage of the loan value.

The APR is a brilliant measurement to use when comparing personal loans to be taken out over a year or more. In this situation, you can clearly see the cost, as a percentage of the amount you borrow, over each year of the loan’s life. You will be able to plan your finances accordingly and clearly see which lender offers the cheapest loans.

However, if you are only going to have the loan for a few weeks or months, the APR will be extremely high, showing only what the cost of borrowing would be if you were to take out a short-term loan but repay it over an entire year, which simply wouldn’t happen.

What’s the best way to compare payday loans, without looking at APR?

So, if you can’t rely on the APR to show you which payday lender offers the best loans, what should you look at? The general consensus in the short-term loan industry is that the daily interest rate is probably the best point of comparison between payday lenders. The FCA already has an imposed limit on interest rates of 0.8 per cent of the value of the loan per day. Most payday lenders charge this amount, but some, including us here at Moneyboat, charge less than the upper limit, making us one of the cheaper payday lenders in terms of the interest we charge on our loans. 

However, it’s not just about interest rates is it? The cost of borrowing is also about factors like charges and fees. Does a lender charge you if you repay early, are there set-up fees and how much are the late payment penalties? APRs that are advertised assume that loans will be repaid on time, but it’s worth checking for penalties that may be added because of missed or late payments, for example, as these too should impact your decision as to which payday lender to go with.

What other factors can I use to compare payday lenders?

As well as APR and daily interest rates, there are a number of other variables that you can look at when trying to find the best value lender. These include:

  • Loan amounts
  • Loan terms
  • Late payment penalties charged
  • Early repayment penalties charged
  • Set-up fees
  • Support offered
  • FCA registration/responsible lender status
  • Eligibility criteria
  • Repayment terms and conditions

It’s important to take the time to shop around for the right type of loan for you from the right kind of provider. If you want a short-term loan but are unsure who to borrow with, ask yourself:

  • How much do I need to borrow?
  • Do I want to repay in a lump sum or over a number of instalments?
  • Do I want the option to repay early without penalties?
  • Do I meet the lender’s minimum lending criteria?
  • Is the provider I’ve chosen a responsible lender that adheres to FCA rules?
  • How much does the lender charge each day in interest?

When you’re considering whether a traditional payday loan will be appropriate for you, or if you would prefer an instalment loan, you need to think about whether you can comfortably cover the cost of repaying the entire loan plus interest in a single lump sum on your next payday. If this will leave you struggling to get through yet another month, an instalment loan might be a better choice. However, bear in mind that the amount you repay in total may be higher if you spread the cost over several months, as more interest will be applied.

What does APR ‘representative’ mean?

You may notice that when APRs are published on lenders’ websites, they often state ‘APR Representative’. Lenders are required to add the ‘representative’ term when an advertised APR is accurate for only 51 per cent or more of borrowers. Therefore, even when an advertised APR is attractive, up to 49 per cent of applicants won’t be offered these rates. Rates that are offered to borrowers are usually based on factors like loan amounts, loan term and the results of the borrower’s credit and affordability checks.

How do payday loans compare with other types of funding?

Payday loans can be an expensive way to borrow, with higher interest rates than loans taken out over a longer repayment period. However, online payday loans are often available on the same day as you apply, providing you meet the borrowing criteria. The industry is also now accountable to the FCA, which has imposed tough new limits on the amount you can be charged in interest and fees. This means you will never have to pay out more than double what you borrow in total, over the entire life of the loan. even if you miss payments or default.

What other sources of speedy cash could I consider?

It’s always a good idea to keep you options open when looking for quick cash. Although payday loans are worth considering if you are the right kind of borrower, you should also look at alternatives that might be more suitable for you. For example, if you have a poor credit rating, you may struggle to get a payday loan from a reputable lender. If this is the case then you can look into the following alternatives:

Credit alternatives

  • Upping your hours/taking on more work
  • Selling unwanted items online 
  • Borrowing from friends or relatives
  • Using savings if you have them

Other forms of credit

  • Credit cards
  • Overdrafts
  • Unsecured personal loans
  • Secured loans
  • Credit union loans
  • Government grants
  • Peer-to-peer lending
  • Lines of credit

Each of these other forms of credit has their advantages and disadvantages and will usually also require you to meet some form of eligibility criteria and credit check requirements. Loans taken out over longer periods of time, such as unsecured personal loans, sometimes end up costing a lot in interest over the entire course of the loan, but monthly repayments may be affordable. Secured personal loans usually involve putting your home or vehicle up as security for the finance, which could see you losing a lot more than just money, should you struggle to repay.

What do most people use a pay day loan for?

If, having read the above, you are still interested in taking out a short-term loan, there are a range of uses for this type of lending. Most people only tend to seek out payday loans when they are in need of quick cash to cover a cost they will be unable to cover until their next payday. If you don’t have a regular income, are unemployed, or have a history of poor credit, you may struggle to be accepted for a pay day loan of any kind.

Common uses for payday loans:

  • Covering the cost of getting your car fixed
  • Getting a household appliance fixed
  • Covering the cost of other domestic repairs
  • Covering unexpected costs, such as:
    • a dentists bill
    • medicines or prescription costs
    • a school trip or meals
    • essential clothing, such as coats and shoes

Despite APR being a poor measurement for payday loans, luckily, consumers can find out everything they need to know through provider websites, online loan calculators and comparison sites. This research will help you, as a borrower, to find the right loan at the right rate, for you. 

Looking for a direct lender loan on a realistic payback schedule?

Warning: Late repayments can cause you serious money problems. For help, go to moneyadviceservice.org.uk

Representative Example: Borrow £400 for 4 months, four monthly repayments of £197.48. Total repayment £597.48, interest rate p.a. (fixed) 255.5%. Representative APR 939.5%. Compare Moneyboat loans.

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