My payday lender told me my loan would only cost 15 percent to 17 percent but my loan documents say the APR is almost 400 percent. My lender says the APR doesn’t matter. What is APR and how should I use it?
Answer: The annual percentage rate, or APR, is the standard way to compare how much loans cost. It lets you compare the cost of loan products on an “apples-to-apples” basis.
To calculate the APR, the interest rate and fees are compared to the amount you borrow and extended over a year. This standard amount of time is how you are able to compare the costs of a credit card to a six-month installment loan, or a two-week payday loan. It is also why APRs are often different from simple interest rates.
For example, if your payday lender is charging you a $15 fee for every $100 borrowed, that would be a simple interest rate of 15 percent. But if you have to repay the loan in two weeks, that 15 percent finance charge equates to an APR of almost 400 percent because of the very short term.
Here’s why: Consider the daily interest cost, $1.07 (or $15 divided by 14 days), then multiply that out for a full year (365 days, so $390.55). So, borrowing $100 would cost you $390 if the term were extended to one year – that’s 390 percent of the borrowed amount.
By comparison, the cost of borrowing the same $100 on a credit card with a 15 percent APR is $15 for one year, or about 57 cents for two weeks.
You don’t need to worry about the math. Just keep in mind that the APR does matter because it provides a shorthand way for you to compare the cost of two or more loans. And, payday lenders must disclose the loan’s APR and other costs before you sign the loan agreement.
Focus on APRs. If you want to compare the cost of a payday loan to the cost of an installment loan or your credit card, focus on the APRs.