Surprised? I was too. After all, aren’t payday loans supposed to the about the worst deal you can get?! While many people (including me) would not assume that taking out a payday or other short-term loan from a provider such as wonga.com would result in lower repayment costs in comparison to main-stream bank overdraft fees, recent research has also highlighted this is the case, particularly depending on the balance of the transaction.
Let’s take a look at this in a little more detail:
What is the Cost of a 1 Month Payday Loan?
Because of this high interest rate, payday loans are absolutely not suitable for longer-term borrowing or if you are experiencing chronic financial difficulties regularly. Recent research from payday loan provider Payday Bank revealed that more than a third (37%) of payday borrowers used payday loans to ease pressure with bills during a difficult time, while a further 28% used payday loans specifically to tide them over in an emergency.
For obvious reasons, payday loans are definitely not the type of loan situation you want to find yourself in, especially considering that credit card interest rates, at 20%, are even considered pricey! However, before we pass judgment too far on these, let’s also take a look at how the fees associated with bank/checking account overdrafts compare with this:
What is the Cost of Overdraft Fees for the Same 1 Month Time Period?
According to the CISI study above, main-stream banks charge overdraft fees totaling an APR equivalent of up to 53,099,884%. Talk about expensive! Does that really say 53 million percent?! That’s and outstanding business return!
Because this sounded pretty wild, I also wanted to check this APR reported with US banks to see how it compares. Below is what I discovered:
- According to Bank of America’s overdraft fee section of their website, they charge $35 per overdraft transaction on the first day the overdraft occurs, and then another $35 every 5 days until the overdraft transaction amount is paid off/you have a positive balance.
- Assuming 30 days in 1 month, this means you will be charged a total of $245 ($35 x 7 total charges) for the one month.
- Since these overdraft charges are on a per transaction basis, this means that the lower the value of the item you are using the overdraft to pay for, the higher the representative APR will be.
- For example, if you had a 1 month overdraft on the 100 GBP / $151 mentioned in the payday loans section above, you would be charged the same $245. This would equate to a $2940 fee on a yearly basis, or an APR of 1,970%.
- On the other hand, if you had the same one month overdraft on only a smaller $50 purchase, this would equate to an APR of 5880%.
- As a worse (but maybe not very realistic) case, for a $1 purchase, this would equate to an APR of 294,000%. What this means is that in order to generate the 53 million percent figure mentioned above, they likely figured it using a purchase of only a few cents. Like I said, maybe not totally realistic, but possibly more effective at driving home their point…
What we can conclude from this is that even though there are better ways to pay for unexpected expenses (emergency fund ideally or even a credit card since it has a lower APR), if the single transaction/purchase you are taking the loan out on is quite large (>$200), it is actually cheaper to use bank overdrafts. However, if the balance is smaller, payday loans are technically cheaper.
Another interesting thought I considered while writing this article was potential reasons for why bank overdraft fees don’t really have the same bad reputation that payday loans tend to carry, despite the fact that they have similar APR’s. Perhaps it is because most of the time, when bank overdrafts happen, they are paid off very quickly, and so do not end up costing the full one month of fees modeled here.
How about you all? Have you ever over-drafted your bank account? If so, how much did it cost you?
Share your experiences by commenting below!
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