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Why APR Is So High for Payday Loans


Payday loans are known for having one of the highest APR rates of all credit products. It can be challenging to understand why payday lending companies are charging such high interest. Much like other forms of short term finance, like installment loans and cash advances, payday loans are a form of high-cost-short-term-credit (HCSTC) and so they charge higher APR to borrowers. You may therefore look at the best alternatives to payday loans before you get started on your payday loan journey, which may include borrowing from friends and family or using a credit card. Here, we run through everything you need to know about why the APR for payday loans is so high.

What Does APR Mean?

The Annual Percentage Rate (APR) outlines the price of the loan over one year. Borrowers can use the percentage rate to understand how expensive a loan product is and better compare products offered by different lenders.

How is APR Calculated for Loans?

APR is calculated by dividing the amount of interest to be paid by the amount of money borrowed. This number is then multiplied by 365 to give the annual price. That figure is divided by the period of the loan and multiplied by 100.

What is The APR for Payday Loans?

When it comes to online payday loans as well as payday loan stores across the country, rates vary from lender to lender, but on average, they are between 400% and 500% in the United States. This works out to between $15 to $30 charge for each $100 borrowed. Therefore, if you are looking to borrow money online or elsewhere, particularly if it is for the short term, you should always check the APR on the loan you fill in an application for for.

Is the APR for Payday Loans Higher Than APR for Credit Cards?

Yes, APR for payday loans is much higher than credit cards and all other credit forms! In comparison, APRs on credit cards tend to range from about 12% to 30%. However, for people with bad credit or no credit history, a payday loan may be the only way they can borrow money quickly and therefore it may be a necessary option regardless of the APR. Other short term loans like online loans and cash advances will charge similar levels of APR to payday loans. 

Why is the APR for Payday Loans so High?

Payday loans have notoriously high APR for a few reasons. They are short-term loans that are unsecured and have a higher default rate than other types of loans. These factors increase the risk for the lender, which they aim to make up for through sky-high interest rates. Also, many payday lenders take the risks of the borrowers into account and so if you have a bad credit score, they balance their risk by charging you more for the loan.

Payday Loans are Short Term Loans

Payday loans are a form of short-term credit designed for emergency use and typically repaid over a far shorter period than traditional loans. Usually, payday loans are borrowed for just a few weeks, giving the customer time to reach their next paycheck. You may need an emergency loan for example and a bank or traditional lender will not be able to lend you the money you need as fast as you need it. Therefore, when you need cash fast, a payday loan or similar product like a home repair loan may be the only place to turn to get you back on your feet.

The APR compounds a product over a year, which in reality would only last a few weeks. As an annual rate, it represents the cost of the payday loan for a far more extended period than borrowers would ever use it in practice. Therefore, it is easy for the APR to reach three figures. 

Unsecured Loans

Payday loans are a form of unsecured loan, which means that they are not supported by collateral or secured against a high value asset like your home or your car, as a mortgage or a title loan would be. If a borrower does not repay a payday loan, the lender can not repossess any financial assets. As a result, every time a lender grants a payday loan, they risk losing their money.

High-Risk of Defaulting

The typical payday loan user is a high-risk borrower. This means that the likelihood of them defaulting on their loan payments is very high. Payday loans are less likely to be paid back by the borrower than any other type of loan. According to the Consumer Financial Protection Bureau, approximately 15 to 20% of borrowers fail to meet their payments, and 1 in 4 payday loans are re-borrowed at least nine times. Because lenders are not guaranteed their repayment, they make up for this loss by charging higher interest rates. 

Payday Loans for Bad Credit

Payday loans are one of the few credit options offered to people with bad credit. Many banks and other lenders refuse to loan money to borrowers with poor credit as well as those in the military who may end up not coming home. Because payday lenders provide products to those with bad credit, they can charge more interest to make up for the risk they are taking. They are also one of the only credit options for this type of borrower and therefore can demand more without losing customers. 

What is the Maximum APR For a Payday Loan?

Shorter-term loans such as payday loans are known for having extremely high APRs. Some states in the USA have APR caps in place. However, for those states without a cap, exceptionally high rates are not uncommon, so it is important that wherever you are, whether you are looking for payday loans in Texas, California, or if you need a payday loan in Ohio or anywhere else, that you look around at different lenders that can suit your needs.

What States Have the Highest Payday Loans APR in America?

While the average payday loan interest rate is around 400%, this can get extortionately high in states without interest rate caps. The average APR in Nevada, for example, is 652%. And, in Missouri, APR rates as high as 1,950% for a two-week loan of $100 would be allowed. 

What States Have the Lowest APR in America for Payday Loans?

However, federal law dictates a 36% interest limit in place for payday lending to military members. Some states, such as Colorado, Montana, New Hampshire, and South Dakota, enforce this APR cap on all payday loans and ban any additional fees. The Center for Responsible Lending recently argued for this 36% cap to be adopted in all states across the country.  

Payday loans have their perks, including same-day cash and quick approval, but they are high-cost loans that come with dangers. If payday loans have unregulated APR in your state, you should always consider any alternative ways to avoid dealing with the extortionate costs!