Recently, several members of an online network were having a discussion about a payday loan. The payday loan company would loan someone $100, and they would have to pay $115.00 back two weeks later. What is the interest rate? (No, this isn’t a word problem on a math test!)
The payday loan company said that the interest rate is 15%, since 15% of the loan is being repaid as interest. While accurate from one perspective, this number is very misleading. The interest rate on nearly all loans is determined on an Annual Percentage Rate, or APR. This means that you look at the interest that would be paid on the loan in a year, divide it by the principal balance, and come up with the APR. For example, if you borrow $100 on January 1 and pay $1 per month in interest for 12 months, the loan has a 12% APR, since 12 ÷ 100 = 0.12 = 12%.
This works for larger loans as well. If you pay $500 per month interest on a $100,000 loan, the APR is computed this way:
$500 x 12 months = $6,000.
$6,000 ÷ $100,000 = 0.06 = 6%
So if you’re paying $500 per month interest on a $100,000 loan, the APR is 6%.
Let’s look at that payday loan again…
$15.00 interest for 2 weeks = $390 per year.
$390 ÷ $100 = 3.90 = 390% APR
So that loan that requires you to pay “only” $115 back in two weeks really has a 390% APR!
If you or someone you know has been overwhelmed with payday loan debt, you may be eligible for a payday loan repayment program. Florida Residents are eligible for a 60-day deferment. Call DMCC 866.618.3328 for more information and free assistance.
DMCC is a 501 (c)3 nonprofit organization committed to educating consumers on financial issues and providing personal assistance to consumers who have become overextended with debt. Education is provided free of charge to consumers, as well as personal counseling to identify the best options for the repayment of their debt. To speak to a certified credit counselor, call toll-free 866-618-3328 or email contact@dmcconline.org.
