Payday loans are widely known as a quick and easy solution for emergency finances. Though it seems like a life-saver, the expected higher interest rates associated with the loans often overwhelm the borrowers. In fact, a very small $15 fee on a $100 two-week loan can cover it to the surprising 391% APR!
So, it’s wise to have a clear understanding of how the interest rate on a payday loan is calculated.
Rest assured, it’s even far easier than you think. Starting from the finance charge to the APR calculation, we are going to cover it in this effective guide. Plus, you will learn the terms of rollover and how they add to the principal of your loan amount. Let’s get started.
How Does Interest Work on a Payday Loan?
Payday loans are shorter-term loans that are mostly famous among people with low credit scores or those who need quick cash. For the loan amount you borrow from the lender, they set a flat fee for every $100, which is known as the interest rate.
Payday lenders typically charge from $10 to $30 or more instead of a percentage-based interest rate. If you want to convert it into the annual percentage rate, it will come in between 390% and 780%, which is enough higher than the APR for other types of traditional loans.
As the payday loan agreement is for very short loan terms, typically 2-4 weeks, it results in such a higher interest rate. The higher the loan amount you are borrowing, the higher the interest rate you may have to consider.
How Do You Calculate The Payday Loan Interest Rate?
Payday loans are often calculated on the annual percentage rate or APR. It shows how much your loan amount costs each year, including interest and fees. Payday loans tend to be expensive due to the higher APR rates. However, lenders set a flat fee for every $100 borrowed that typically ranges from $10 to $30. It can vary depending on the lenders and the state laws.
So, if you know the finance charges of your payday loan amount, you can easily calculate the APR on your payday loans. Here is the simple formula:
APR = (The set fee on your loan/ loan amount) x (Number of Days in a Year / Loan Term in Days) x 100
For example, you want to take a specific loan amount that is $5000. The charge is about $25 per $100 borrowed for a 2-week loan. Now the query is, how much would a $5000 payday loan cost? Here is the math:
Step 1: Calculate the fee of your payday loan
Fee= $5,000 x 25%
Or, $1,250
Step 2: Calculate the APR
APR = ($1,250 / $5,000) x (365 / 14) x 100
= (0.25) x (26.07) x 100
Or, 651.75%
So, as you can see, a $5,000 payday loan for 2 weeks with a charge of $25 per $100 borrowed would cost you an APR of 651.75%.
Let’s say again you have agreed with the terms of $20 per $100 borrowed, and you have borrowed about $375 for the 2 weeks.
Then the APR will be ($75 / $375) * (365 / 14) * 100 that is about (0.2) * (26.07) * 100.
Or, 521.4%.
Calculating the Interest Rate for the Loan Term:
Now that you know the repayment amount of your loan for the period you borrowed the money, you can easily find out the interest rate of your loan.
For example, you are borrowing $300 with about $60 as a fee for a 14-day loan term.
Now, the interest rate would be:
(Total Fees / Loan Amount) * 100%
($60 / $300) * 100%
Or, 20%
So, the interest rate for the 14-day term is about 20%.
How Do You Calculate The Rollover Loan In The Payday Loans?
Rollover is likely extending the due date of your loan terms. For this, the lender may charge you an additional fee, which does not reduce the amount you owe. The borrower is still owed the principal of the loan amount and the extra fees for the rollover.
For example, you have borrowed about a $1,000 loan, with about $20 per $100 borrowed for a 2-week loan. Unfortunately, it has been rolling over for about the 3-month loans, and that is why you will charge the additional fees.
To calculate the amount, first, we will figure out the actual fee of your loan amount based on the set finance charges in your loan term.
Fees= $1,000 x 20%
Or, $200
After rolling over for the 3 months rolled over,
Rollover Fees: $200 per rollover x 3
Or, $600
So, the total fees after 3 months of rollovers: $200 (initial fee) + $600 (rollover fees)
Or, $800
Now that you want to calculate the APR, it would be
($800 / $1,000) x (365 / 90) x 100
Or, 324.8%.
So you can see, for the extended loan terms, you will be owed to repay for about 324.8% APR, which would be around 521.4% without the rolling over.
What Happens If You Default On A Payday Loan?
Payday loans are short-term terms as well, and you are committed to the repayment in your next paycheck. In case you miss repaying the loan on time, there are a few consequences you may need to consider. Have a look:
Credit Damage
For the late repayment, your credit score will be highly affected. The lender will send your debt to a collection agency. The collection agency is more likely to report your unpaid debt to the credit bureaus, which can damage your credit score.
Late Fees
Payday loans often come with late fees if you miss a single repayment date. The lender will charge additional late fees, which can quickly add up and sometimes make it harder for the borrower to repay it. Sometimes, it starts for each day or week when the loan is not repaid. You are likely entering a continual debt cycle.
Lawsuits
In severe cases, the payday lender or collection agencies may take legal action to get back the due amount. If you lose the lawsuit, the court will enter a judgment against you. In case of such a judgment, the lender or collector gets a court order to garnish your wages, through which they can take a portion of your paycheck directly to pay off the debt.
In Closing
Payday loans offer quick access to cash, but the higher interest rates often seem like a hectic financial burden for most borrowers. So, a better understanding of how payday loan interest rates are calculated can save you from surprises. We have simplified the overall formulas with relevant examples to let you understand just how quickly the costs can add up.
Well, before taking any decision, we recommend tracking all the payday loan options. Make sure to borrow from the preferred payday lender to avoid any distractions in the path of your expected life journey.
Frequently Asked Questions
Can payday loan fees change?
Yes, payday loan fees can vary depending on the lender and state laws. Always check the loan terms carefully before borrowing.
Can I avoid high payday loan fees?
Now, there is no chance of avoiding the high interest rates of the payday loans. One thing you can ensure is repayment on time; otherwise, it will return to the debt cycle with the latest and rolled-over fees.
