What is the Interest Rate on a Short-term Loan?

What is the interest rate on short-term loans

Under FCA regulation, the maximum interest that a short-term lender can charge for the loans they offer is 0.8% interest per day. This is equivalent to being charged 80p interest each day on a loan of £100. The interest you pay in total can never be more than the original amount you borrowed.

This means that the most interest you can ever be charged on a £100 loan, is £100.  While some lenders also charge late payments fees, there are rules that cap the cost of late payment fees that lenders can charge you. These overall limits are included in the cost of borrowing. So, even if you incur a late payment fee, you will still never pay back more in interest and fees than the amount you originally borrowed.

If you apply for more to cover extra expenses or to allow for treats, you’ll still have to repay this. As a result, it could take you longer to repay the loan, and the additional interest costs will mean higher repayments that could cause financial difficulty.

What is APR on short-term loans?

APR stands for Annual Percentage Rate. It is the percentage you’d repay your lender, in interest, if you borrowed from them for 12 months or longer.  APR is a useful way to compare the cost of different lenders and get an impression of how much different types of credit cost.

The calculation that determines the APR of a loan is incredibly complicated. It takes lots of information into account and also makes some assumptions. For example, APR calculations assume that all lenders charge compound interest. With compound interest, you pay interest on the total amount outstanding, which includes interest already added to your balance before.

But, some lenders choose to charge simple interest. This is where you only pay interest on the amount borrowed, and not on interest previously added to your balance.

The APR calculation also assumes that you are borrowing for a year or longer. This isn’t typically the case with short-term loans, which true to their name, are designed to last just a few weeks or months. As a result, APR isn’t always the best way to work out how much interest you’ll be charged in pounds and pence.

With short-term loans, the APR quoted often exceeds 1000%. But, with the FCA’s caps on the cost of credit, you will never pay anything close to this much interest. The most you can ever repay in interest and fees on a short-term loan is capped at 100% of the amount borrowed. So, if you borrow £100, the most you’ll ever payback for that loan in total is £200.

However, the high APR that comes with short-term loans shows that they should be viewed as just that: short-term loans. While you may never end up paying back 1000 times more than you borrow, short-term loans are a comparatively expensive form of borrowing. They are not suitable if you have longer-term borrowing needs.

Before you apply for any kind of credit, you should carefully consider your financial situation. Make sure you can afford the repayments, and make them on time, even if your circumstances change.