My payday lender said my loan would cost 15 percent but my loan documents say the annual percentage rate (APR) is almost 400 percent. What is an APR on a payday loan and how should I use it?

Answer: The APR, or annual percentage rate, 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. Your lender must disclose the APR before you agree to the loan.

To calculate the APR, the interest rate and fees are compared to the amount you borrow and calculated over a one-year period. This allows you 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 $391 if the term were extended to one year – that’s 391 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. Remember, your lender must disclose the annual percentage rate (APR) and other costs before you agree to the loan. If you were not given this information, your lender violated the law. You can file a complaint with your state regulator and attorney general. You can also submit a complaint with the CFPB online or by calling 1-855-411-CFPB (2372).

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