How Calculating APR for Payday Loans Save From a Debt Cycle?

APR stands for “Annual Percentage Rate,” and it is a way to measure the cost of a loan, credit card, or line of credit. It is measured on annual basis and is expressed as a percentage of the loan amount borrowed. A loan or credit card includes a certain fee or charge, don’t assume that it would be always included in the APR because some fees, like title fees on a mortgage, are not part of the loan process. That’s why for financial products like mortgages or credit cards, APR can get complicated. APR can be misleading with amortizing installment loans as well. These are paid off in a series of equal, regular payments, so a certain portion of each payment always goes towards your principal loan amount. With time the principal goes down, so is the amount of money that is accrued in interest. So, if you would calculate the APR over the decreased principal balance at any point through its term the figure would be different because the advance fees and interest is already paid.

Payday Loan APRs are Very Simple To Understand

Payday loans do not amortize so the principal stays the principal and the interest stays the interest. The interest on a payday loan is referred as a “finance charge” and it is a fee based on the borrowed amount. For example, a $300 payday loan that costs $20 per $100 borrowed would have a finance charge of $60. Just make sure it does not  include any hidden. Calculating APR should is a brilliant way to get the estimate of the expensiveness of a short term loan.

How to Calculate the APR for Payday Loans ?

First of all gather the following information:

• The principal loan amount
• Finance charge
• Repayment Term

For example:

Principal loan amount = $400
Finance charge = $80
Repayment Term = 14 days

The calculation goes like below:

Divide Finance charge by loan amount = 80/400=0.2(which means borrower will pay 20 cents on every dollar borrowed)

Multiply that result by 365(number of days in a year)= 0.2 x 365 = 73

Then, divide that result by the repayment term= 73 / 14 = 5.214285

To convert into APR, just move the decimal point two spaces to the right and add a percentage sign.

Hence, 521.43% is the calculated APR

Why Do Some People End Up in a Debt Trap ?

Many people who borrow short term loans end up trapped in a long-term debt cycle. The reason behind this is that because near repayment due date, they discover that they cannot afford to pay it off. So, they choose to roll their loan over or take out a new loan to repay the outstanding loan. While doing, they unintentionally increase the cost and debt. Every time the loan is rolled over, interest is charged at the exact same rate as before which means more money to be repaid. Same happens in the case of borrower takes out a new loan to pay off for the former one.

According to the Consumer Financial Protection Bureau, 80% of payday loans are the result of rollover because average payday loan customer takes out 10 payday loans per year. So, make sure to calculate APR beforehand so that you may know how much the loan is going to cost and if your can afford to repay the total amount on the due date. After all, it is game of numbers!