What is APR And How Does It Work?

APR stands for Annual Percentage Rate and tells you how much your loan is going to cost over a single year. However, APRs can be confusing, especially because payday loans are often repaid in less than 12 months. Therefore, in this post, Dollar Hand is going to go through some frequently asked questions about APR so that you can make fully informed decisions.

 

Key Points:

• Annual Percentage Rate (APR) represents the cost of a loan over a single year.
• APR is calculated through a certain formula but because of hidden fees a lower APR does not always mean a cheaper loan!
• Most payday loans will range from anywhere between 390-780% APR.
• Representative APR shows the rate that more than half of the lender’s customers truly pay.

 

 

What Is APR?

 

The Annual Percentage Rate (APR) is a crucial financial term used to express the cost of borrowing, including both the interest rate and any additional fees or charges associated with a loan or credit product. APR provides borrowers with a standardized way to compare the overall cost of different financial products, such as loans, credit cards and mortgages, regardless of their specific terms and structures.

In essence, APR gives you a more comprehensive understanding of the true cost of borrowing by considering not just the interest rate, but also any upfront fees, closing costs and other expenses associated with the loan. 

The APR of a payday loan represents the cost of the loan over a single year. Borrowers can use the percentage rate to compare loan products from different lenders. The lower the APR, the less the interest will be.

Different types of APR are summarized in the table below:

 

Nominal APR:	This is the simple interest rate charged on the loan. It does not take into account any fees or other expenses. Nominal APR is sometimes referred to as the “stated” or “advertised” interest rate.
Effective APR:	Also known as the “true” APR, this accounts for both the interest rate and any additional costs associated with the loan. It provides a more accurate representation of the total cost of borrowing.
Fixed APR:	This type of APR remains constant throughout the life of the loan, regardless of any changes in market interest rates.
Variable APR:	With a variable APR, the interest rate can change over time, typically in response to changes in an underlying benchmark interest rate.

 

 What Is Your APR If You Are Borrowing For Less Than A Year?

 

The APR is a percentage, which is proportionate to the value that you’re borrowing. It works as an annual percentage, showing the cost of funds for one year, regardless of the duration of the loan. 

The APR for a payday loan is calculated by dividing the amount of interest paid by the amount of money borrowed. Then, this figure is multiplied by 365 to represent the annual rate. Then, that figure is divided by the length of the repayment term and multiplied by 100.

This sounds complicated and it is! It can be difficult to understand APR but often finding the lowest APR for your credit card or loan will be the cheapest for you. 

 

Is APR The Best Way To Understand If A Loan Is Too Expensive? 

 

APR isn’t always the most helpful way to assess how much a payday loan will truly cost! The cost of your loan will depend on how much you borrow and how long you borrow for, as well as other factors.

Most importantly, do not get caught out by hidden fees! Remember that the lender can choose which fees are included or excluded in the APR. It’s vital to make sure you can afford the loan repayments. If you fail to pay, there may be late fees and added interest, making the loan more expensive.

 

 

How Do I Find Out The APR Of My Payday Loan?

 

In the United States, lenders are legally required to display the APR on any advertisements or marketing information for their products. Therefore, it will always be easy to see what the APR of your payday loan will be. This allows you to easily compare between different lenders.

 

Is “Representative APR” The Same As APR?

 

The term ‘Representative APR’ is often used by payday lenders. It is important to note this is not the same as the APR shown when you are originally offered the loan. 

The representative APR is the rate that more than half of their customers actually pay. It allows consumers to see what the payday loan costs the average customer. You can use representative APR as a basic measure of how expensive a lender is.

 

What Is The Maximum APR?

 

Shorter-term loans typically incur high APRs. These can range from anywhere between 390-780% APR. Many states in the USA have APR caps in place but Native American lenders and states without a cap, can have exceptionally high rates.

 

Why Is The APR For Payday Loans So High?

 

Payday loans are most often repaid over a much shorter term than traditional loans. This condenses the APR rate even if the cost is the same. 

As a result, payday loans are renowned for having one of the highest APR rates. By contrast, APRs on credit cards can range from between 12% to about 30%. 

 

Why Is APR Important?

 

APR provides a standardized way to compare the total cost of borrowing across different loans and credit products. It helps borrowers make more informed decisions by considering the full picture of expenses. When shopping for loans or credit, comparing APRs allows you to easily determine which option is the most cost-effective in the long run, regardless of variations in interest rates or terms.

As well as this, by including both the interest rate and fees, APR offers transparency about the true cost of a loan. This transparency is crucial for borrowers to avoid unexpected costs.

Moreover, in many countries, financial regulations require lenders to disclose the APR alongside other loan terms. This ensures that borrowers have clear information to make informed decisions.

 

Final Thoughts

 

APR is a critical tool that empowers borrowers to make informed financial decisions by providing a standardized way to compare the total cost of borrowing across different loan products. APR offers transparency and clarity, helping borrowers avoid unexpected costs and enabling them to choose the most suitable financial options for their needs.