Understanding APR On Payday Loans

APR stands for annual percentage rate and helps you to understand how much a loan would cost over the course of a year. However, because payday loans are a form of short term loan that’s usually paid back in 35 days or less (depending on the lender), APR becomes more complicated. Read our guide on understanding APR on payday loans so you’re fully equipped to find the best price and understand your loan.

You could also use our payday loan comparison tool! We find you the best deal from trusted direct lenders on payday loans or instalment loans.

apr - annual percentage rate

Payday Loans and APR

If you’ve looked at payday loans, you might have already noticed that the APR seems particularly high in comparison to other loans that run over a longer period. Understanding both payday loans and how APR is calculated will help you understand why this is and how it should influence your decision when choosing a payday loan.

What is A Payday Loan?

A payday loan is a form of small, short term loan that’s designed to help you financially when unexpected costs arise before your next payday. They are for people who know that they’ll be able to pay back the money after they are next paid, but need to cover an unforeseen cost for which they didn’t budget.

Because of the nature of payday loans, you’ll borrow money for a period between 1-35 days (up to around a month), making them one of the shortest forms of loans.

What is APR?

APR stands for annual percentage rate. You’ll see it represented as a percentage which calculates the yearly amount that you’ll pay for a loan. It includes everything: both the interest on the loan and any other fees you have to pay.

The key thing to remember about APR is that it calculates the cost of a loan over a year. When a loan is longer than a year, the total cost is added up and divided to give you an average for each year. When a loan is shorter than a year, the cost is multiplied to represent what it would hypothetically be if it was a loan spread over a year.

Representative and Typical APR

You might have heard of two forms of APR: representative and typical.

By law, every lender has to use the same process to calculate APR to ensure that the person borrowing money gets a fair representation of how much the loan will cost and can compare it to other places.

However, representative and typical APR each have a few different variables that mean APR ultimately might look higher or lower on paper and in each circumstance. For example, if you have borrowed reliably from a lender before, they might trust you with a lower APR than someone they’ve never lent money to before. This means there are a lot of factors that affect the actual APR of your personal loan.

Representative APR refers to the rate which 51% or more of borrowers are offered.

Typical APR refers to the rate that two thirds or more of borrowers are offered.

You are more likely to get a rate closer to typical APR than representative, especially if you’re never used that lender before.

APR On Payday Loans

If you’re considering a payday loan, you’ll have likely already begun to look into different options and have noticed that the APRs on payday loans (and other short term loans) are typically higher than on other kinds of financial products.

Short term loans are usually a more expensive way to borrow money than other loans, but they have the distinct advantage of offering fast cash which you pay back within a short period of time. This means that they might not be as costly as the APR could suggest at a glance.

This is because APRs are most commonly used to calculate the cost of longer term loans, such as paying for a car, a mortgage or a long term phone contract. Short term loans usually don’t last longer than a few months, and payday loans are rarely longer than a single month.

This means that APR may not be the most helpful way to calculate the cost of a payday loan. It represents how much that loan would cost over the course of a year, not the month (or less!) for which you’re borrowing the money.

APR Example

In other words, because APR looks at the annual rate of a loan, it makes interest rates seem even higher. An interest rate of 290% pa could translate to an APR of over 1500%. However, in reality, this might look like borrowing £100 over the course of 10 days and paying back £107.95.

For example, if you were to borrow £50 from a friend and buy them a drink the next week to say thank you that would similarly be a very high APR.

It’s also worth noting that the FCA, who regulates lenders, caps payday loan interest at 0.8% per day.

Calculating Cost

By law, lenders have to specify the APR on every loan they offer, but this can be misleading as it won’t help you understand the actual amount you’re going to pay.

The best method to use when looking at payday loans is to focus on the overall cost, the ‘total payable’ value. This will show you precisely how much you’re going to have to pay so you know that you’ll be able to afford repayments before taking a loan, and that you’re getting the best deal.

To ensure that you’re getting the best payday loan, use our loan comparison tool at Clear And Fair. We’re a comparison website that works out all the details for you. You can specify the precise amount you need to borrow and for how long and see which lender can offer you the best price for the loan.

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