Payday Cash Advances or Unauthorised Bank Overdraft - Which Type Would You Opt For?
When the media starts reporting on payday loan advances, you can be sure that they will mention the seemingly high representative APR. It seems that the entire media is set on having a go at the payday loan companies labelling them everything under the sun from loan sharks to out and out thieves. So is it all as bad as the media will have you believe?
It is a popular topic of discussion but for people who are not fully aware of how an APR (Annual Percentage Rate) actually works, which is most people, it is very easy to jump to the wrong conclusion. We are all conditioned to evaluate credit offerings by comparing the APR of financial products. However, this causes a huge problem when evaluating short term loans.
Annual Percentage Rate was introduced to enable the comparison of interest rates on an annual basis and this is the cause of the problem. It is the amount of interest applied to the loan in a year. As most traditional loans run for terms of a year or more, using the APR to compare the loans works ok. Payday loan advances on the other hand, only run for a term of around 7 – 31 days. So by using an APR to describe payday loan charges, you grossly distort the actual figures.
Usually a payday lender will charge around £25 for every £100 borrowed for the agreed duration of the loan. This means that if you borrow £200 for 28 days, you repay £250 when it is time to pay back the loan. That calculates out at an interest rate of 25%. Yet the APR is around the 1737% mark, which is totally misleading.
So is the APR irrelevant when it comes to payday loans? If you take out a hire car for a day, you want to know how much it is going to cost you. You want to know that it is £40 a day, not £14,600 per annum. Most payday lenders make the costs of borrowing totally transparent and up front. You know before you take out the loan that if you borrow £200, it will cost you £50 in charges, assuming that you pay back the loan on time. No other lending practice is that transparent.
So using an APR to compare payday loan advances gives a totally distorted picture. As it happens, the Office of Fair Trading support this viewpoint. When they published an interim report on high-cost consumer credit they said:
“Consumers appear to find the inclusion of the total repayment amount more helpful than an APR in understanding the cost of short-term credit. This may be due to the information distortion which results when an APR is applied to low sums over short periods.”
What is interesting is that, high street banks are not required to display their charges for overdrafts as an APR. I wonder what they would do if they did as unautherised overdrafts can attract charges and interest that amounts to APR in the millions!
If you bank with Lloyds TSB and go overdrawn for 10 days by £200 without permission, you would pay £85.95 in charges. This consists of eight daily charges of £10 for being overdrawn without permission, a £5 ‘usage fee’ and 95p interest. These charges equate to an APR of 46,450,869%.
Lloyds dispute this by saying that the charges are capped at £85 monthly. However, if you were to have gone overdrawn by a smaller amount, the same fee structure would apply making the APR even more astronomical.
With Santander, an unauthorised overdraft of £200 could cost you £60.68, an APR of 1,586,122%.
So although quoting the APR when it comes to payday loan advances does not actually help the consumer, it is the actual charges being made by our high street banks that are the truly staggering numbers in the world of finance. Yet they do not have to display these charges as an APR, and they are often buried in the small print so they often go unnoticed.
Britain’s banks currently charge up to £20 a day on unauthorised overdrafts. It is only the fact that the banks recently won a high court battle, alongside the fact that there is no astronomical attention grabbing APR to publish, that allows them to get away with it.
Banks made an estimated £2billion from charges such as these in 2009 so it is little wonder that they will do whatever they can to protect such a huge source of revenue.
So are payday loans too expensive? Well, if you have no other choice available other than to go overdrawn without permission, then considering those costs, I hardly think so. Find out more about payday loan advances here.
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