Money

Short Term Loan APR Explained

1000% APR? How can a company that is here to help charge such high interest? The answer is simple: we don't. For short term loans, the APR and the interest rate aren't the same thing.

Smart-Pig has to display an APR by law, but it's a fact that the way it's calculated means for loans shorter than a year APR won't reflect how much you pay. Confused? We don't blame you.

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?
A: £1
Q: What's that as a %?
A: 1%
Q: So what is the APR of this loan?
A: 3678%

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.

If you're looking for Smart-Pig's interest rate, it's 0.8% per day (or 292% per year) - however, we cap the interest you 50% of what you borrow - even if you run into trouble repaying.

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”.

If:

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)

Then:

x=-100x((c/d)^(1/S)-1)x(c/d)^-(1/S)

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.

More articles in Money

× Warning: Late repayment can cause you serious money problems. For help, go to moneyadviceservice.org.uk