A payday loan is an urgent cash advance loan given to those who need money urgently. It is a short-term loan given for a period of up to 14 days and the sum is usually between $100 and $1000.
Straightforward payday loans are given to salaried persons working with a salary of at least $1000. Payday loans are given quickly without any cumbersome paperwork or complicated procedures.
There is even no credit check carried out or collateral insisted. The reason is the loan is given for a short period and meant to be repaid on the next payday.
Payday loans have to be repaid within 14 days or a maximum of 31 days. It is usually taken by people who run out of money mid-month or end of the month and need urgent cash for an emergency.
When they get their salary next payday, they need to repay the payday loan. Since this is a loan, interest is charged by the lender as the reward for the risk taken by them in giving the loan.
Payday loans carry a higher interest than other loans since they are given urgently and are short-term loans.
If you are taking a payday loan, you will need to understand the interest you need to pay and how the interest rates are calculated.
The following information about payday loans will help you understand the calculation.
Payday loan concepts
Lender: The lender is the person lending or giving the payday loan. It may be a private individual or an organization.
Borrower: The borrower is the loan taker or the person to whom the loan amount is given.
Loan amount: This is the total amount taken by the borrower. In payday loans, the minimum amount is $100 and a maximum of $1000. In very rare cases, amounts above $1000 are given.
Loan term: This is the period of duration of the loan, which is usually 14 days extendable to a maximum of 31 days.
Interest amount: This is the charge collected by the lender to cover his costs and profits. It is calculated based on the APR
APR: This is the rate at which the interest is calculated and also known as the annual percentage rate.
Due date: This is the date on which the loan is due to be repaid along with the interest. It is calculated based on the date the loan was given and the loan term.
Amount due: This is the total money to be repaid on or before the due date. It is usually the sum of the loan amount and interest amount. Any other fee charged is added to this.
Payday loans interest calculation
The interest calculation depends on the APR or Annual Percentage Rate. This is the rate at which interest has to be paid every year.
The rate is decided by the lender and usually varies from lender to lender.
This is the reason borrowers are advised to apply to different lenders and compare the interest rate before deciding.
The lower the APR, the lower is the interest amount to be paid.
Some states in the US have laws that specify an upper limit on the APR. This sets a ceiling or the maximum APR.
Lenders can charge any APR of their choice but it must not exceed the limit fixed by the state law/regulations.
This again varies from state to state.
You need to look into the applicable state laws in your city to find out what the APR ceiling is.
Lenders may either use the APR for the purpose of calculation or work out a cost per $100. Let’s see how this works:
To calculate the APR, you need to know the finance charge. The formula to calculate finance charge is the loan amount divided by 100 multiplied by the fee for every $100.
APR is then calculated as a finance charge divided by loan amount multiplied by the number of days in the year divided by the loan term. The answer is multiplied by 100 to get the percentage.
Let’s understand this in a more easy way using an example.
A person borrows a payday loan of $1000 for a loan term of 14 days. The lender charges an interest amount of $20 per $100, which is known as the fixed fee.
Step 1: You need to divide the total loan amount by 100.
1000/100 = 10
Step 2: You need to calculate the finance charge by multiplying the result of Step 1 with the fixed fee.
10 x 20 = 200
Step 3: Divide the finance charge by the loan amount
200 / 1000 = 0.2
Step 4: Multiply the result from Step 3 by the total number of days in the year.
0.2 x 366 = 73.2
Step 5: Divide by the loan term
73.2/14 = 5.2285
Step 6: Multiply by 100 to get the APR in terms of percentage
5.2285 x 100 = 522.86% (rounded off to the second decimal).
As we can see from this example, the APR for a loan of $1000 taken for a term of 14 days for a fixed fee of $20 is 522.86%.
The APR is mentioned by the lender and this needs to be verified by the borrower before taking the loan.
Some lenders may not specifically mention the APR but may mention the fixed fee, which is the fee charged per hundred dollars.
In case, the latter is mentioned, you can work out the APR using the formula and example explained above.
Now that you know how the APR is calculated, it is important to know what it means:
1. The APR tells you the annual percentage rate for a particular loan. It is important to know this number as the state fixes an upper limit for the APR.
Knowing the APR will help you verify if this ceiling is followed.
2. You can use the APR value to compare lenders. Check the APR offered and select the lender who offers the least APR.
The information on interest rate calculation will help you decide the best lender to work with when you take a payday loan.
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My name is Harold Mitchell, I’m part of the editorial team at the Payday Locker. We offer Online Payday Loans in Michigan. Payday locker is a third-party agent that helps you connect with a lender and get money instantly.