5 November 2013 Last updated at 04:08 Payday loans are advertised as a short-term stopgap until your next payday. But what if you can't pay them back? Each year over 2 million payday loans are 'rolled over' for another month, and the high interest rates mean monthly interest can soon spiral out of control. You can see how with this interest calculator.
On any loan, the two key things that affect the interest cost are the annual percentage rate of interest (APR) and how long you borrow for. Drag the bar below to set the APR. Then hit PLAY to see how the interest goes up each month. To compare the interest on two APRs, hit COMPARE.
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10 key facts about APR and monthly interest APR stands for Annual Percentage Rate.
The annual percentage rate on a loan is the amount of interest the lender would charge you if you borrowed the money for a year, as a percentage of the original loan.
For instance at 40% APR, the interest you would owe after a year would be 40% of the original loan.
So if you borrowed £100, the interest charged would be £40.
When lenders advertise loans, they must show the APR by law. People borrow money for different lengths of time, so the annual percentage rate gives a standard way of comparing interest rates.
It doesn't mean the lender will actually lend you money for a year, but it's the standard for comparing deals.
Continue reading the main story Interest rates
- Per cent just means per hundred. So for money 1% is 1p in the pound. 50% is 50p in the pound.
- A loan at 10% interest per year charges 10p for every pound borrowed every year
A simple way of thinking of APR is how many pence interest it would cost you to borrow each pound, per year.
So for instance at 40% APR, on each pound borrowed you would pay 40p interest a year.
At 400% APR, on each pound borrowed you would pay 400p or £4 interest a year. At 4000% APR, you would pay 4000p a year, that's £40 interest on each pound borrowed.
A simple way to think of APR is how many pence interest it would cost you to borrow each pound, per year.
An APR of over 100% just means that if you were to borrow for a year you would pay more than 100% of the original loan in interest. So for each pound borrowed, you'd pay interest of more than 100p.
For APRs over 100% a quick and easy way to read them is to imagine a point in front of the last two figures.
For instance 4670% APR becomes £46.70. This is the interest you would pay on each pound borrowed, per year.
See the box and link on the right for more information about percentages.
No! As well as the APR which they must show, some lenders advertise a monthly percentage interest rate, which looks much smaller.
However beware: this monthly percentage rate is applied each month to the current balance owed, including any interest added so far. Because the monthly percentage rate is applied to a growing balance each month, the interest goes up faster and faster each month and can soon start to spiral out of control.
At 40% a month interest, after 3 months the balance owed has more than doubled.
So if you roll over the loan for another month, or take out another loan to pay off the first one, the next month's interest is likely to be significantly MORE than the first month's interest, which you still owe. And if you couldn't afford it the first month, will you be able to afford even more the second month?
The higher the monthly rate, the faster the interest soars. With lower interest rates the balance grows more slowly so the monthly increase is more manageable. For instance credit unions are capped at 3% a month interest, which is just under 43% APR, or 43p interest per year on each pound borrowed.
Payday loans are short-term, high-APR loans, usually designed to be paid off completely at your next payday. Instalment loans are longer-term, lower-APR loans, which you pay off in regular instalments to spread the cost. If you need credit longer term it is worth looking into lower-APR instalment loans, for instance from a local credit union.
No. The APR lenders show on their adverts is NOT necessarily the interest rate you personally will be charged. It may be just a "representative" rate. In practice lenders often charge different people quite different APRs depending on their circumstances and credit history, so you may actually be charged more than the rate in the advert.
Many lenders add various extra fees and charges on top of the interest, especially for late repayment. Sometimes people only realise too late that they haven't read the small print.
Make sure you fully understand all the charges before you commit to borrowing. And take your time to look at the small print, don't be afraid to keep asking until they have explained it all clearly, or to walk away. It is the lender's responsibility to make it clear what you are signing up to!
Payday loan adverts often emphasise how fast you can receive a loan. But this may mean you rush into borrowing money at very high interest rates.
Lenders such as credit unions or banks may take a day or two to process your loan request and check it's affordable. But they usually have much cheaper interest rates, for credit unions capped by law at below 43% APR, which could save you a lot of money on interest in the long run. And because credit unions are not-for-profit they may be more sympathetic to your personal financial situation.
For more information on credit unions near you visit the Association of British Credit Unions website. Or watch this short video-clip about credit unions.
Remember to think carefully about the cost of any loan, including the interest and any charges, and how and when you will get the money to pay it back. If you can possibly plan to save some money at the same time, you can start earning interest instead of paying it.
