Calculating Interest on a Payday Loan

The Federal Truth-in-Lending Act requires lenders to be very clear on the terms involved in payday loans (cash advance loans.) Before you sign any paperwork or leave a post-dated check for the money owed, make sure you understand how the fees and interested are calculated.

Most payday loans are due in one to four weeks. If you sign loan papers that promise payment in eight days and interest and fees are calculated weekly, that eight-day period will extend to two week's worth of fees. You will not see payday loan companies offering an APR (Annual Percentage Rate), the interest rate calculation that shows what a year's worth of financial is costing you. Mortgages and car loans always use the APR. This is why many people don't understand what payday loans really cost. People are used to interest in an APR format.

Typical Interest and Fees on a Cash Advance Loan

States have different laws, and some don't have any, so you should start by finding out what the limits are in your state. Most states limit the interest charged by payday loan companies to 15%. This means for every $100 you borrow, you'll pay $15. A $500 loan therefore has $75 in fees. Some states don't cap interest at all, so you could be paying 50%. That's a lot of money to pay.

Calculating the APR

The way an APR works is that you take the finance charges and divide them by the amount you've borrowed. So $75 divided by $500 comes to 0.15. Multiply that by 365 days in a year (54.75). Now divide that by the number of days you have before your payday loan is due (3.91). Move the decimal two places and you have the APR. If you had 30 days before your payday loan was due, the APR is better at 182%.

Making Payday Loans Work Effectively for You

Knowing how the APR is calculated can help you figure out how to make the most of your payday loan to get the best APR. In the above case, borrowing the money for a full month makes more sense. Just make sure you have the money in your account on the day the money is due.

Never borrow more than you can afford and make sure you pay it all back when it's due. Don't roll it over into a new loan where fees get higher and interest adds up.