Best Startup
Personal loan and payday loan providers tend to target consumers who are unable to take out traditional loans and who are therefore seeking payday loans and other forms of short term personal finance.
This means that they may be less creditworthy, lack steady income and are constantly seeking funding. Additionally, these borrowers may be looking for everything from a $1,000 loan to needing to borrow larger amounts of money in a short period of time. All of these factors make these borrowers high-risk; as a solution, lenders offer the loans with high APR (annual percentage rate) meaning that they are able to make a profit on the interest rates.
Many people who need to borrow money online will turn to short term and payday lenders who are able to offer quicker funding and a vast range of short term loan products
What is APR?
APR (annual percentage rate) represents the annual costs of funds for a lender and is paid by borrowers when they take out a loan. It is calculated as an annual percentage, regardless of the length of the loan term. APR can include interest rates as well as any additional fees that the lender may wish to include.
What is the difference between APR and the cost of funds?
Cost of funds refers to the amount of money that a financial institution must pay in order to obtain funds. Generally speaking, the lower the cost of funds, the greater the return will be when lending money. Remember that APR can be charged on any credit ranging from a credit card to a course of laser hair removal paid for with a credit option and even your car and other loans.
This difference between cost of funds and APR is incurred by borrowers and will be where financial institutions and lenders make their profit. Lenders will always assess the cost of funds before deciding whether or not to lend as this allows them to see how profitable the deal will be for them.
How high is the APR for payday loans?
Payday loans are notorious for their sky-high APR rates. Exact APR will vary from lender to lender and will also depend on where you are taking out a payday loan. Different states in the USA for example will have different laws when it comes to payday loans with some states banning these types of loans completely while some have specific price caps; some states still operate with no restrictions.
The average APr for a payday loan is typically around 400% – this is the equivalent of $15 to $30 for every $100 borrowed. Comparatively, credit card APR is between 12% to 30% on average.
In the states that operate with no restrictions on payday loans, APRs can be as high as 390% to 780% APR.
Why is APR higher for payday loans than other types of loans?
One of the reasons for the higher than average APR for payday loans is their high-risk.
Because the target demographic is borrowers who cannot secure a loan by traditional means and who has an unstable borrowing profile, lenders have to protect themselves from potential default of payment. These loans are also unsecured so there is no collateral that the lender could reclaim if the loan payment is defaulted.
Another reason why APRs are so high is due to the short-term basis of payday loans. APR is calculated on an annual basis regardless of the length of the loan term. Subsequently, if a borrower wants to take out $200 across 2 weeks, 5% of that loan will be $10. If this lending fee is then done as an annual charge, that means rolling over the interest rate 26 times. Before you entertain the idea of any other costs or fees, that is already an APR of 130%.
