Short Term Loan APR Explained
“Wonga lends at over 5000% APR!” I hear people cry on a daily basis. Well, yes… but honestly, that means very little.
There are a lot of things wrong with short term loan companies, but funnily enough high APRs are not one of them, because for loans shorter than a year they don’t reflect how much you pay.
Take this example we use on the Smart-Pig website.
Say someone offers you a loan of £100 for 1 day. You have to repay £101.
Q: How much has the loan cost?
Q: What's that as a %?
Q: So what is the APR of this loan?
See the issue? How does 3678% relate to the cost of the loan? How is it relevant? Well, it’s the cost of taking out a loan on the same terms again and again and again over the course of a year, borrowing more each time to pay off the last loan. And that’s just not possible. Either way, £1 to borrow £100 for a day sounds pretty reasonable – you’d buy a friend a pint if they gave you an £100 advance. It’s also more sensitive to loan duration than the actual price of the loan, which can be misleading.
So how do we come to 3678%? Well, the APR formula is a bit complex, and allows for multiple drawings and repayments. Luckily many terms of the full calculation drop out when there is only one “drawdown” and one “repayment”.
x = APR in %
c = amount borrowed (£100)
d = total amount to be repaid (in one payment on the due date £101)
s = duration of the loan in years 9so number of days the loan is for divided by 365 days in the year, 1/365)
APR% = -100 x ((100/101)^(1/365)-1) x ((100/101)^-(1/365)) = 3,678%
And the pint? In my local that’s about £3… 4,848,172% APR.