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Why the APR of Payday Loans Doesn't Matter

hundred dollar bills
Getting a payday loan sounds more and more like borrowing a financial ticking time bomb than money.

Most media coverage talks about how “this legislation” or “that legislation” will curb or ban payday loans. This war on payday loans has been waging across the country ever since the cash advance lending industry began booming in both the online and offline realms.

Politicians have been forced to define their positions on the matter, some claiming support, while others fight against short-term loans for people in need.

However, politicians aren’t the only voices in this debate.

Aside from politicians and the cash advance industry, consumer activists are the third voice in this three-party scuffle. One argument that consumer activists constantly use against borrowing payday loans is the high annual percentage rate (APR) that comes with obtaining these types of financing. However, calculating the APR of cash advances is a completely erroneous use of interest rate calculation for a loan lasting a matter of days.

The first casualty in a war is Truth, and in the Payday Loan War that idiom unfortunately proves to be accurate.

APRs and Interest are Apples and Oranges

Payday loan APRs can be quite high on paper, but their importance for short-term loans is massively misleading. Unfortunately, anti-payday loan voices often disregard the true correlation (or lack thereof) between annual percentage rates and cash advances.

The only reason that APRs appear on cash advance financing forms is that they are required by law under the Truth in Lending Act. The legal requirement to include an APR on all payday loan documents is a vain attempt to help educate borrowers on the interest they would pay over the course of a full year.

But payday loans aren’t one-year loans. Cash advances are intended to only be borrowed for two weeks — hence why they are lumped into the short-term loan category.

Since these short-term loans are only intended to be borrowed and repaid within a matter of days, it is foolhardy to think that their two-week interest rate should be stretched out to a year-long interest rate for the sake of political posturing.

APRs are constantly used by consumer advocates and anti-payday loan voices as an argumentative weapon in the “Payday Loan War.” Since this war is partially fought in the halls of Congress, it is no surprise that the erroneous use of APRs has been manipulated into a talking point by anti-payday loan activists.

That being said, this does not mean that borrowers shouldn’t be told about the interest they will be paying.

Proper Interest Rates

All instant loan companies should and must tell their borrowers how much they will owe and when they will owe it.

Even industry insiders agree with the need for truthful clarity. The problem, however, arises when an improper measuring tool is used to gauge the payday loan product.

Jamie Fulmer, Senior Vice President of Public Affairs for Advance America, told loans.org that even consumers feel that APRs are not appropriate indicators of the price of short-term loans.

“Describing the one-time fee associated with payday loans as an annual percentage rate doesn’t tell you the cost of the payday loan, but rather the cost of taking out a loan every two weeks for a year – that’s not how customers use short-term loans,” said Fulmer. “That’s like walking into the grocery store and seeing hamburger meat priced by the ton, or pulling up to a parking meter that says it costs $8,760 to park for a year instead of $1 an hour.” 

While we are all very grateful that we do not have to calculate the true cost of our 8 ounces of hamburger meat that’s being priced by the ton, instant loan borrowers are not so fortunate.

Until sensible legislation is put into place to reflect how much interest is paid over a two week period, rather than a year-long period, the use of APRs in hollow arguments against instant loan financing that people demand will continue needlessly.