The annual percentage rate (APR) for payday loans is known as being one of the highest in the loans market. The high-risk nature of payday loans means that lenders are able to charge higher interest rates than traditional lenders with around 1,000% APR charged in the UK and around 400% in the USA.
The key reasons that the APR for payday loans is so high is due to being an unsecured financial product, expensive operating costs and high default rate.
Payday loans are typically only short-term (around 2-4 weeks) and popular uses include household emergencies and bills but APR is calculated on an annual basis. This means that a weekly figure is multiplied by a minimum of 12, already reaching a high figure for the APR. So even though rates are around 0.8% per day and at 24% per month, when compounded, this can quickly grow into a figure of 500% to 1,000%.
To reflect on the type of product, payday loans are unsecured meaning that they are high risk for lenders as they are not supported by collateral. This means that the borrower is not offering up any collateral in the form of financial assets.
Should the borrower be unable to repay, lenders cannot repossess anything and have to use damage to a credit score, additional fees and chase up letters – with nothing physical to help recover costs. Given that there is a lot to lose, this is reflected in a higher interest rate and APR.
Unlike other types of loans, payday loans are known for a low rate of repayment, making them even more high-risk for lenders. The borrower demographics of payday loans are typically those who live pay cheque to pay cheque and may have less than perfect credit histories.
Statistics suggest that only 14% of payday loan borrowers can afford to repay the loan at the end of the term. In a similar vein, a quarter of payday loans are re-borrowed a minimum of 8 times.
Finally, payday loans are subject to offering higher APRs because of their operational costs. To get a strong, qualified lead from a customer may cost £10-£20 ($15 to $25) and after credit and affordability and a faster payment service, the lender may have spent quite a bit already, just to fund a £200 or $250 loan.
You also have regulation and licensing costs from the FCA or membership costs if you are in the Us – and this further adds to your running costs.
Overall, this is also reflected in the price and combined, you find an APR which is much higher than the average credit card or personal loan.
expensive for the lenders as they need to secure instant funds for a very short-term at a very high risk. On top of this, lenders need to fund the cost of running a payday loan store, running credit checks, the logistics of instant payments and employee salaries.
