What is an annual percentage rate (APR) and why is it higher than the interest rate for my payday loan?

Tip

Focus on APRs. If you want to compare the cost of a payday loan to the cost of an installment loan or a credit card, focus on the APRs.

When looking at the cost of your payday loan, using the APR allows you to get a more accurate estimate of the loan’s costs as well as compare costs across different credit products, so you can decide which one works best for your situation.

To calculate the APR, the interest rate and fees are compared to the amount you borrow and the number of days of the loan, then divided by 365 (one year). For example, if your payday lender were to charge you a $15 fee once per year for every $100 borrowed, that would be a simple interest rate of 15 percent. But if you’re required 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 by 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 30-percent APR is $30 for one year, or about $1.25 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 quicker way for you to compare the cost of two or more loans.

Remember, your payday 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 has violated the law. You can file a complaint with your state regulator and attorney general . You can also submit a complaint to the CFPB online or by calling (855) 411-2372.

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