Wednesday, May 6, 2009

Why the APR Calculation is Misleading


The Annual Percentage Rate describes the costs of the loan in annual terms.

The Annual Percentage Rate (APR) will vary depending on the number of days that pass between the date the customer receive their advance and the day they repay the loan. The term of the loan begins when the funds arrive in their bank account, so when selecting the Number of Days, make sure to subtract appropriate time for the loan request and fund-disbursement processing (about a day).


The APR does not consider:

1. The size of the loan: The costs of providing a small of $200 or a large loan of $20,000 are very similar. Small lenders still need the same staff, programs and equipment. However, a larger loan principal allows the lender to recover more costs in a more discrete way. That is, the APR appears lower in proportion to the loan amount borrowed. Yet 10% of a $200 loan $20, whereas 10% of a $20,000 loan is $2,000. Who earns more? Regardless, the two lenders are still judged on the same grounds.

2. The length of the loan: Larger loans that run for 5-30 years are able to collect interest over longer periods of time which lowers their Annual Percentage Rate. Although in actual fact they recoup anywhere up to 100% interest whereas payday lenders only charge approx 24% as a percentage fee.

3. Convenience premium: When the costs of the credit provisions are considered, service providers that offer final approval just one hour after applying, such as ourselves, have to hire additional staff and utilize resources in the most cost effective way. Unlike other financial institutions that leave customers waiting for up to 10 days whilst they process the application, we hire more staff and increase our investments in technological efficiency which must then be translated into a convenience premium.

4. Risk: The payday lending industry is riskier than most other financial sectors and institutional ventures as we provide loans to clients who often have credit rating concerns.

5. Value: It is far more valuable to our clients to receive $100 today and repay $124 next month to have the money available. It's the same with families who borrow $250,000 for their family home and end up paying back $500,000 years later. Our applicants use our fees as the real price signal - they don't make decisions based on the APR which disregards the difference between a one month loan and a thirty year loan.

6. Demand Discounts: Clients who borrow more are offered a lower interest rate for one reason- the costs of providing a larger loan is the same as providing a smaller one. Also, if you are acquainted the Supply = Demand theorem, those who borrow more are privy to lower interest rates whilst those who borrow less pay higher premiums.

7. Maintenance Fees: The APR does not disclose any late fees or maintenance fees that can be incurred during the life of a loan. Often these fees result in financial institutions overstepping the current legislation. This too can be said for the big 4 banks.

8. Acceptance and compliance: There is a great deal of confusion between corporate entities as to whether they comply with the regulations. There are very few resources available to aid in their disclosure processes. As a result, many do not disclose their APR or do so incorrectly.

9. Academic Criticisms: Many academics have openly criticized current legislations as ineffective scare tactics which reduce competition and hurt the 'Mums and Dads' in society.

10. Payday loans don't last an entire year: Payday applicants only borrow up tor a month or two at most so will never end up borrowing for an entire year. Therefore, they will never end up paying anything close to the APR.

Some payday loan clients (as with all other financial services) face numerous financial difficulties independent of the payday lending industry.

By bridging the gap between paydays we aid our customers in reducing dishonour fees and overdrawn account fees. Further, Payday lenders aid households in reducing fluctuations in their standard of living and help maintain consumption. After all, high default rates = reduced profit = reduced funds to re lend = operating cost not met = bankruptcy. It is in our best commercial interest to lend to members who can repay the loan rather than crippling our own cash flow.

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