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The Myth of the 36% APR Cash Advance Loan

May 23, 2008
"What is wrong with lenders who think they need to charge more than 36% APR? If they can't make money at 36% APR then they should be out of business," quips the well-intentioned blogger who reads about cash advance lenders who state time and time again that a 36% annual percentage rate loan would force the lender to close its doors.

This claim and others from community members are well-intentioned, but an honest look at the numbers reveals what it costs to provide such credit. A closer look at the issue is warranted and will reveal what APR consumers are really paying for short-term loans and other similar financial products.

Payday Advances Began as a Fee Based Business

More than a couple of decades ago lenders were required to explain to the borrower that they would pay a fee of 10% of the amount borrowed to receive a few hundred dollars for a couple weeks. Over time, Congress stipulated that the annual percentage rate needed to be provided to borrowers to help them measure the cost of credit. Short-term loans such as payday loans were included in this federally mandated program even though the outstanding loan never accrued interest for a full year.

Consumers who were used to paying 8 to 15% of the face amount of a loan were now told that the money they were borrowing was costing them 391% APR or even greater. Why such a high APR when the business model stayed exactly the same? For the simple fact that cash advance loans are intended and often limited to terms of less than 30 days. When combining the average loan fee of $10 for a $100 loan with a short term of two weeks, lenders are often required to display triple digital interest rates.

"Why Don't Lenders Only Charge 36% APR on Two Week Loans"?

This is a fair question. If lenders could remain profitable and offer loans at this APR they would. The competition surrounding cash advance lending is fierce and many lenders strive to deliver their product at the lowest cost possible to the borrower. One issue that all short-term lenders face is fixed costs. Fixed costs are generally the same, regardless of the lender, loan amount, or loan product. Every lender from a payday loan provider to a credit union has to pay rent, utilities, salaries, advertising, and cover bad loan costs with the fees they charge their borrowers.

A report issued by the accredited accounting firm, Ernst & Young in Canada, revealed that it costs a lender $15 dollars to lend $100 to a new customer. Regardless of the efforts of lenders, they cannot reduce these fixed expenses. Furthermore, a short-term lender needs to recoup these expenses within two weeks. For other loan products, such as cars and real property, these costs can be spread out and recovered over months and years, resulting in a lower APR.

Why a 36% APR Won't Work for Short-Term Loans

A 36% APR on a $100 dollar, two week loan, would provide the lender a fee of $1.38. As the above mentioned paragraph stated, the average costs of providing a loan can exceed $15.00 per $100. This shows that lenders cannot issue short-term credit at a low APR.

This issue is not unique to cash advance loans. Overdraft protection charges often have an APR of 800%, credit card late fees can exceed 1000% APR and a simple ATM access fee of $1.50 to get $40 dollars can exceed 1200% APR! It becomes easier to see why many consumers choose to utilize cash advance loans when facing a short-term credit need.


Although the notion of a low APR short-term credit product is appealing, it cannot be viably offered to the public. In October of 2007, Congress limited credit provided to members of the military to 36% APR. The idea was noble, but instead of lenders issuing short-term loans at 36% APR, they simply refused to lend to members of the military. Many soldiers and sailors were left without viable and reasonable short-term credit options.

Many members of the armed services were forced to utilize other, more expensive credit products such as bounced check fees, overdraft protection plans, and late fees. These fees can end up costing consumers hundreds or thousands more than a well-regulated payday advance loan. Now I ask you again, "Does it make sense to cap the industry at 36% APR, or is there a better solution"?
About the Author
Michael New Jr. is an authority in the financial industry. He has written hundreds of articles relating to consumer services and Payday Loans.

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Michael New Jr.
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