A guide to payday loans and APR

You must know what the APR is

One of the many criticisms aimed at text loans and other short-term credit facilities and other short-term credit facilities is that they are extremely expensive.

MPs, consumer champions and others routinely point to the APRs attached to these loans as proof of why people should give them a wide berth.

It is true that payday loans come with much higher APRs than traditional forms of finance, with some APRs running into several thousands. However, there is a very good reason for this, which is that payday loans differ from loans provided by high street lenders in almost every way.

Loan providers are required under law to provide an APR, however, how much do you really understand about APRs?

APR stands for annual percentage rate and lenders are obliged to tell you the rate before you sign an agreement with them.

The Financial Services Authority defines APR as:

"The annual percentage rate of charge. You can use it to compare different credit and loan offers. The APR takes into account not just the interest on the loan but also other charges you have to pay, for example, any arrangement fee."

It is important to note at this juncture that the advertised APR is not necessarily the one you will receive.

The advertised rate is what the majority of applicants will get, but not all, so the chances are you may have to pay a higher rate than that advertised, at least as far as bank loans are concerned.

APRs have many critics, who claim they can be confusing and complicated and this is particularly true when it comes to payday loans.

If you understand the nature of payday loans and what they are designed to do, you will know that they are short-term loans designed to help people meet one-off costs or see them through a short period until they get paid.

The key word in all of this is short.

Most people borrow for only a few days, with the majority aware that you should not take out payday loans for longer than a month.

What relevance then, has an annual percentage rate to payday loans if people only take them out for a month at the very longest?

The answer is not much, which is why many would-be borrowers get confused.

For example, let us say that you wish to borrow a sum of £250 and repay it in 21 days' time and let us say that the lender you choose charges an APR of 4,214 per cent.

That means you will have to repay the original sum of £250 and interest and fees of £58.42. The APR is still 4,214 per cent but since you are only borrowing over a three-week period, it is nowhere near as expensive as the headline rate may suggest.

This is one of the features of payday loans that critics fail to grasp. If you were to take out a payday loan over a 12-month period at an APR of over 4000 per cent, it would prove very expensive indeed.

However, payday loans are not designed to be taken out over 12 months. They are designed to be taken out over a few weeks or a month at the most. So the APR is only calculated over a number of days rather than a year.

All loan providers have to provide an APR and it is important that you know what rate you will be paying. However, with payday loans, always work out how the interest and fees you will pay over the number of days you intend to borrow for.

By doing this, you will understand why payday loans make a lot of sense for a lot of people.