As featured in The Wall Street Journal, Money Magazine, and more!
     

Payday Loans Fees and Interest Rates: Fair Comparison?

This article was written by in Debt Reduction. 6 comments.


I consider payday loans one of the worst forms of debt. That being said, in states where these services are still legal, they provide a way for struggling individuals to afford necessities like food and housing until their next paycheck, for a fee. Unfortunately, many borrowers don’t simply use their paycheck to pay back the loan and move on when it is due. One loan is often rolled into the next, for another fee.

A typical fee for a payday loan is $17 per $100 borrowed. That fee is due when the loan is repaid, usually within one or two weeks. While this cost of the loan could be considered a 17% fee, an annual rate is used to compare payday loans with other loans. The annual interest rate for a consumer loan from a bank may be 10%, but the payday loan works out to an annual rate of almost 450%, assuming the loan carries a term of two weeks.

The operative phrase is “a term of two weeks.” How is it rational to compare these two products using an annual interest rate? Only if the loan is extended and renewed repeatedly does it become a significant financial burden worthy of the interest rate stigma of 450%.

I am not defending payday loan companies. These lenders prey on individuals and families in desperate financial situations, often with nowhere else to turn. There is a strong possibility of borrowers falling into a spiral of increasing debt with back-breaking fees, and this is why these products are becoming illegal in more states. Arizona is the latest state, banning predatory loans with interest rates higher than 36%.

I do, however, believe the numbers used in the argument against payday loans are often illusory. Should loans due within two weeks annualize their fees into interest rates to face comparison with long-term loans?

Updated March 7, 2012 and originally published July 14, 2010. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

Email Email Print Print
avatar
Points: ♦127,485
Rank: Platinum
About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 6 comments… read them below or add one }

avatar Investor Junkie

Hey Flexo,

I posted a new blog entry also discussing payday loans.

http://investorjunkie.com/2624/payday-loans-vs-loan-sharks/

My argument is who are week to determine what’s fair and if these loans were so bad, why do many people continue to still use them??

The funny thing if you took effective APY for other things like late fees, with banks and other bills, people would be amazed of how much they are being charge.

It literally “pays” to be good with money.

Reply to this comment

avatar Split Cents

I think the APR approach works just fine if used to describe the business practices of payday lenders or the overall effect on consumers. In fact, most people do the math wrong, and fail to account for the fact that “interest” earned by payday lenders is compounded bi-weekly if they continuously re-lend!

I don’t think consumers are being duped here, since a payday lender is certainly not going to do the math for them and present them with an annualized rate.

Reply to this comment

avatar Split Cents

Actually, I am completely wrong in my last comment, payday lenders *must* disclose the total finance charge as well as the cost of the loan per the Truth in Lending Act… and that will likely be calculated with daily compounding

Reply to this comment

avatar Jenna

I think that Payday Lenders should have to offer weekend courses on money management or something to make sure their clients are fully understanding where their money is going and how much in the end their loan is going to cost them.

Reply to this comment

avatar Mooper

If you withdraw $100 from an ATM and pay a $2.50 fee, you are essentially borrowing money until you redeposit the amount back into your account (the cost is the same, the only difference is that you are forgoing interest you would have had instead of owing interest). If your paycheck is two days away and it takes you that long to replace the depleted funds, then your $2.50 fee alone equates to roughly a 450% interest rate as well. This is a ridiculous way to analyze a very beneficial service that a lot of people want.

If consumers seek and are willing to pay a fee, they should be allowed to. Transparency, disclosure, and education are different issues, but it is nonsensical to outlaw the product. It says a lot that Payday lenders go out of business when limited to a 36%-equivalent fee… it shows that the cost of lending to people who engage in these loans is much higher, validating the need to charge so much. No one *has* to borrow from these companies, but they should be allowed to, as long as the companies fairly disclose their fees.

Reply to this comment

avatar OLDAQUA

Bad math mooper. Let’s say you don’t redeposit the $100 for 12 months. You have paid $2.50 or 2.5% interest. Now lets say you do the same thing with a pay day loan. Remember, the $17 is ‘renewed’ every two weeks or $34 a month. In 12 months you’ve paid $408, or 408%. Seems to me that’s a bit higher than 2.5%.

Reply to this comment

Leave a Comment

Connect with Facebook

Note: Use your name or a unique handle, not the name of a website or business. No deep links or business URLs are allowed. Spam, including promotional linking to a company website, will be deleted. By submitting your comment you are agreeing to these terms and conditions.

Notify me of followup comments via e-mail. You can also subscribe without commenting.

Previous post:

Next post: