31 Mar What Does the APR (Annual Percentage Rate) Really Mean?
Recently, several members of the Bankruptcy Law Network were having a discussion about a payday loan. The payday loan company would loan someone $100, and they would have to pay $115.00 back two weeks later. What is the interest rate? (No, this isn’t a word problem on a math test!)
The payday loan company said that the interest rate is 15%, since 15% of the loan is being repaid as interest. While accurate from one perspective, this number is very misleading.
The interest rate on nearly all loans is determined on an Annual Percentage Rate, or APR. This means that you look at the interest that would be paid on the loan in a year, divide it by the principal balance, and come up with the APR. For example, if you borrow $100 on January 1 and pay $1 per month in interest for 12 months, the loan has a 12% APR, since 12Ã·100 = 0.12 = 12%.
This works for larger loans as well. If you pay $500 per month interest on a $100,000 loan, the APR is computed this way:
$500 x 12 months = $6,000.
$6,000Ã·$100,000 = 0.06 = 6%
So if you’re paying $500 per month interest on a $100,000 loan, the APR is 6%.
Let’s look at that payday loan again…
$15.00 interest for 2 weeks = $390 per year.
$390Ã·$100 = 3.90 = 390% APR
So that loan that requires you to pay “only” $115 back in two weeks really has a 390% APR!
In my day, they used to call that “usury” to be nice but what it really is is “loan sharking.” It used to be illegal. Now I guess it’s just considered good business.
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