Payday loans are the easiest, fastest, and most convenient way of raising cash when someone is in a tight financial situation. In addition, they’re easily accessible, and the lending requirements are relatively lenient compared to traditional banking institutions. As a result, this option is often attractive for users with bad credit scores and those who can’t find reprieve elsewhere.
Payday Loan Interest
But as with any loan, it’s essential to learn how interest rates work and how they’re calculated. Interest rates are the most important thing to look at when considering a loan. Understanding how lenders calculate interest rates puts borrowers in a better position to negotiate or minimize the interest amount payable. For this reason, here’s some insight into how payday loans are calculated.
How do Interest Rates Work?
When a payday lender quotes an interest rate, they’re likely referring to the Annual Percentage Rate (APR). Generally, the interest amount payable is determined by three factors:
- Annual Percentage Rate
- Principal (amount loaned)
- Repayment period
For example, an amount of $1,000 with an APR of 120% and a three-month repayment will attract a total of interest of $206.33. But if the same loan amount under the same APR is paid with one month, the total interest payable will drop to $100. In other words, the three variables are directly related, and a change in one of them affects the interest owed.
What is the Typical Interest Rate on Payday Loans?
The Annual Percentage Rate for payday loans varies depending on the applicable legislation and the specific state. But based on the requirements of the Uniform Small Loan Laws (USLL), the average APR should fall somewhere around 40%—subject to other contributing factors.
Are Payday Loans Available Throughout the U.S.?
Different states have different regulations regarding payday loans. In some, payday lenders are held to an interest cap. For example, Idaho prohibits the payday lending of amounts that exceed 25% of the borrower’s income. In addition, payday loans are prohibited in other states such as Arizona, Arkansas, and the District of Columbia. With this in mind, it’s advisable to confirm eligibility for a payday loan by checking applicable state legislation.
Borrow responsibly. Payday loans are an option for dealing with financial emergencies—but they aren’t designed to be long-term solutions. The longer you hold the loan, the higher the interest amount payable. The general rule of thumb is to pay off the debt as soon as possible.