APR of Payday Loan

Quote of the Day

There are only two hard things in Computer Science: cache invalidation and naming things.

Phil Karlton. I worked on cache memory designs while at HP and I can attest to the difficulty of cache invalidation. Also, I have struggled with coming up with meaningful names for software objects. Neither task is simple.


Introduction

Rep. Katie Porter (Wikipedia)

I watched a video (Figure 2) that shows Rep. Katie Porter (Figure 1) grilling the Director of the Consumer Financial Protection Bureau (CFPB) Kathy Kraninger in regards to the calculation of a payday loan's Annual Percentage Rate (APR). This blog post will show how to compute the APR for the payday loan example Rep. Porter attempts to get Ms. Kraninger to compute. I am not sure Ms. Kraninger knows exactly what APR is. The questioning is a bit uncomfortable because Ms. Kraninger is in no mood for a math exercise and Rep. Porter is not going to give up. Ms. Kraninger clearly is uncomfortable, but her discomfort is nothing compared to the discomfort experienced by a payday loan customer.

This exercise will compute the APR for a Rep. Porter's payday loan example of $200 principal with a $20 origination fee, 10% interest, and 14-day term. A finance person should be able to estimate this metric in their sleep.

Background

Definition

APR
APR is a standardized metric that represents the annualized cost of a loan, including fees and interest, to a borrower expressed as a percentage. It is not an interest rate because it includes fees and cannot be used to compute payments. Because the APR calculation is standardized, it provides a convenient way to compare the relative costs of different loans.

Rep. Porter Video

Figure 2 shows Rep. Porter interrogating the CFPB director.

Figure 2: Rep. Porter Grilling CFPD DIrector over APR.

Analysis

APR Mathematical Definition

I will use Investopedia's formula for APR (Equation 1).

Eq. 1 \displaystyle APR=\left( {\frac{{Fees+Interest}}{{Principal}}} \right)\cdot \left( {\frac{{365}}{N}} \right)\cdot 100

where

  • Fees are any non-interest costs associated with the loan is considered a fee.
  • Interest is the interest paid on the principal.
  • Principal is the amount of money owed.
  • N is the loan payback period in days.

Calculation

Figure 3 shows my calculation for the APR of Rep. Porter's payday loan example. The APR is 521%, which is a horrendous rate.

Figure 3: Payday Loan Calculation Example.

Conclusion

Payday loans are another example of financial services companies preying on the unknowing. A 521% APR is ridiculous. Unfortunately, I see this sort of thing all the time. I caught a broker for a major investment firm try to cheat my retired mother out of her retirement money by churning her portfolio – he had no business putting an 84-year-old's money into high-risk stocks. I have also seen insurance agents sell multiple small life insurance policies to maximize their sales commissions.  Again, clearly not for the benefit of their customers. I hope the CFPB eventually gets some enforcement teeth and some qualified management.

 
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1 Response to APR of Payday Loan

  1. NotACapitalist says:

    Thank you.

     

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