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Grade 9-12
,
Lesson

How Expensive are Payday Loans?

Updated: February 25 2016,
Author: Hilary Hunt

Assessment Activity

Multiple Choice

  1. Which of the following is a characteristic of a payday loan?

    1. Loans are typically for amounts ranging from $500-$1,000
       
    2. Loans can be paid off in part or in full at any time
       
    3. [You need a checking account in order to get one]
       
    4. They are only used by people with bad credit
       
  2. Rasheem goes to a payday lender and borrows $450. He is told the finance charge will be $50 for two weeks. What is the total cost of his loan if it takes him six weeks to pay it off?

    1. $625
       
    2. [$650]
       
    3. $800
       
    4. $1,850

 

Constructed Response

Mary Ellen is comparing offers for payday loans from two different companies. She needs to borrow $600. While she knows both payday lenders loan money for two weeks at a time, she doesn’t feel that she will have the money to pay it off in just two weeks. She will pick up extra hours at work to save the money and hopes to pay it off in eight weeks. What would the total cost be at each lender? How much more expensive is the most expensive offer? Show your work.

Fast Cash advertises a finance charge of $90 for a $600 loan. Cash Now advertises a finance charge of $18 for every $100 you borrow.  

[For each lender, the number of rollovers or R would be (8/2) or 4.]

Fast Cash:

Total cost = Loan amount + Finance charge (1 + Number of Rollovers)

                                        T = L + F(1+R)              

t = 600 + 90(1+4)

t = 600 + 90(5)

t = 600 + 450

t = $1,050

 

Cash Now:

Before using the formula, the finance charge also needs to be determined. Since she would borrow $600, the rate of $18 for every $100 borrowed needs to be calculated as (600/100)x18 = 6 x 18 = 108.

Total cost = Loan amount + Finance charge (1 + Number of Rollovers)

                                        T = L + F(1+R)              

t = 600 + 108(1+4)

t = 600 + 108(5)

t = 600 + 540

t = $1,140

Using Fast Cash would cost Mary Ellen $1,050 while using Cash Now would cost her $1,140. Cash Now would be $90 more expensive.

Overview

Payday loans are used by consumers to meet short-term needs for cash. A typical two-week payday loan with a $15 per $100 fee equates to an annual percentage rate (APR) of almost 400%. The APR is the percentage of the principal of a loan to be paid as interest in one year and provides a way to compare loans. In this lesson, students will learn that many users of payday loans pay much more than they initially borrowed because of the costs of multiple renewals or rollovers. A rollover occurs when a borrower cannot repay the payday loan in full at the end of the term (usually two weeks) and then must continue the loan or take out a new one. Students will also use formulas to calculate the total cost of the loans and the APR.

Sources

  • Federal Trade Commission 'Payday
     
  • Federal Trade Commission 'Payday