How much does a loan cost?

How to calculate the cost of a payday loan

It might seem like an obvious question, but it’s amazing how many people fail to actually consider the cost of a loan before taking one out. And we don’t mean the amount you will need to repay each month, but the actual cost, to you, as the borrower, in addition to the repayments.

When you take out a payday loan, for example, you commit to repaying the value of the loan itself, as well as the interest charges, plus any fees, penalties or extra costs involved. Depending on the type of loan and the lender you choose, the interest and the extra fees might be a significant sum. It’s the interest and the extra fees and charges that we are going to look at in this article. We’re here to equip you with the knowledge you need to choose a loan wisely.

How to calculate interest on a loan

Starting with interest makes sense as, no matter which lender you choose, you’ll need to pay interest. This is, after all, the way lenders make money. There would be no point in lending people money if they didn’t repay the loan with interest.

What isn’t quite so clear to borrowers is how to actually calculate how much a loan will cost you in terms of interest. Sure, lenders will proudly talk about their APRs and daily interest rates (ours is 0.7% per day by the way - the lowest around when it comes to short-term loans), but what does this mean in hard cash?

What does daily interest mean?

A daily interest rate is the percentage of the loan amount you will be repaying each day that you have an outstanding balance. Although the interest rate might be displayed as a daily percentage, the daily interest will be multiplied by the number of days that have passed since your last repayment. Then you will be charged the cumulative interest for that period.

What does APR mean?

We’ve taken a close look at APR and how they aren’t the best way to measure the cost of short-term loans in previous blogs. APR stands for Annual Percentage Rate and shows the cost of your loan, displayed as a percentage of the total loan amount, including interest and all fees and charges.

APRs are great for comparing the cost of more long-term loans (especially those that are actually likely to hold for at least a year). However, for loans that are only ever intended to be taken out over a few months, the cost over an entire year is a largely irrelevant, and pretty unhelpful measurement.

Loan calculators

You could try working out the cost of a loan yourself, but the best way to find out how much a loan will cost you is to use an online loan calculator. These will take into account factors like your balance reducing as you repay, and the impact this will have on your interest rates. There are lots of loan calculators available online. Comparison sites are a good place to start when looking for a reliable calculator.

What other charges and fees can add to the cost of a loan?

It’s amazing what some loan companies will try to charge you for. You can protect yourself from paying unnecessary fees and charges by doing your research before you agree to a loan and looking out for all charges and fees applied to the loan you are considering.

Late payment fees will almost always apply to your loan. The amount you will be charged if you make a repayment late or fail to pay will be set out in your credit agreement, so it’s vital that you look for this piece of information in particular. Late payment fees can mount up if you are late making repayment regularly. If you make a habit of missing repayments, the cost of your loan can quickly spiral.

Remember - all interest and charges should be set out in your credit agreement, so read this carefully before signing. Interest rates cannot be increased during your loan period and charges cannot be introduced after you have signed the agreement.

Loan cost caps applied to payday loans

Following years of unscrupulous actions from some payday lenders, the Financial Conduct Authority (FCA) stepped in and introduced some strict regulations on the industry. These days, it’s much harder for payday lenders to lend irresponsibly or to allow borrowers to run up enormous bills that they simply cannot afford to repay.

The changes came into force in 2015 and capped the daily interest rate for payday loans to 0.8%. Unsurprisingly, this is the daily interest rate that most payday lenders now charge. Although some, like Moneyboat, choose to offer a better deal, with a daily interest rate of just 0.7%, which represents a significant saving on the cost of your short-term loan.

In addition to the cap on daily interest charge, the FCA also imposed a cap on the total cost of a short-term loan. Now, regardless of how long you take to repay your loan, or how many payments you miss, you will only ever have to pay costs amounting to 100% of your loan value. So for a £200 loan, the loan can only ever cost you a further £200 in interest and charges, so £400 in total, including the repayments themselves.

The takeaway...

The most important thing to remember when taking out a short-term loan is to make sure you know how much it is going to cost you before you sign up. Credit agreements should not be ignored, take the time to check out the small print and check you understand what missing payments will cost.