The FCA recently put caps on the maximum interest rate chargeable per day for payday loans at 0.8%. The FCA also put caps on the maximum amount of fees and charges at 100% meaning that you can never pay more than you borrowed in interest and fees. Although this puts an end to unfair lending practices that were common in the past, this doesn’t mean that every payday loan you come across going forward will be cheap. Far from it! There are still payday loan lenders that are more expensive than others so, here’s how to determine the real cost of a payday loan
Understand the structure of payday loans first
To be able to find out the real cost of a payday loan, you need to understand how payday loans are structured. Payday loans are short term loans that are meant to be paid off during the next pay day i.e. in a month or less. As a result, they feature shorter terms and lower loan amounts than typical loans. They, however, have more fees than typical loans.
The interest charges usually denoted as APR look at the interest that a borrower would pay in a year divided by the principal balance. For instance, if you are borrowing $1000 and you are supposed to pay $10 in interest per month for a year (12 months), the APR for the loan will be 12% i.e. 120 divided by 1000. The most important thing to note is payday loan lenders calculate interest daily even though they denote it as APR. Interest, therefore, add up faster than typical rates so do independent calculations.
The total amount of interest you should expect to pay = Annual interest rate/365 days x term of the loan in days x loan amount.
It’s also worth noting that the payday loan interest you pay depends on the loan amount as well as the term of the loan. You tend to pay a higher interest rate if you borrow a larger amount and stay with the loan longer than usual (i.e. more than a month) because interest is charged daily.
Since payday loans are usually offered over short time periods, payday lenders can’t make as much money unless the loan is repaid over a long period. As a result, payday lenders focus on making money on fees.
Different lenders may have different fees . However, you should look out for establishment fees and monthly fees among other fees that are a fraction of the principal amount borrowed since such fees tend to be the most costly.
You also need to consider other fees like default and fees. Such fees are usually charged when you miss a payment, so it’s important to know how much you stand to pay in the worst case scenario. Default fees are charged when you default on your payday loan. The fees can include an amount that is continuously charged until you are able to repay your loan. There is, however, a cap set by the FCA.
The total amount of fees and interest charges you pay on your payday loan in the UK can never exceed the loan amount you received. This cap is effective for small amounts. If you have borrowed large amounts, you will definitely pay a lot in interest and default fees. This explains why you need to know exactly what you stand to pay will charge you.
Enforcement expenses are fees incurred by a lender as they pursue you to pay your defaulted loan. The fees may include things like lawyer/court expenses.
Some lenders may also have an early repayment fee to discourage payday loan borrowers from repaying their loans too early i.e. after a day. To get the real cost of your payday loan, you must add up all these fees.
The real cost of your payday loan equals the interest charges plus all the fees applicable. Most borrowers usually pay attention to the interest rate figure and assume charges can’t be much. This shouldn’t be the case. The only way to find out the actual cost of your loan is to add up all the fees.