Typical 2689% APR…Eh??

When a friend’s Facebook status mentioned a website offering loans for a TV at 2689% APR, I was intrigued. It sounds astronomically high, doesn’t it? – The answer, as always in Economics, is that “...well it depends…”

Firstly, APR stands for annual percentage rate and is the interest payable on the amount borrowed and other charges expressed as an annual rate of charge.

Secondly, the website in question is called Wonga.com - “Wonga provides small and super-flexible loans around the clock. We’re here to help solve urgent and short term cash flow problems.

Wonga’s business model is based on lending money (maximum £400) for short durations (maximum 30 days).

So if you borrow £100 for 30 days you owe £136.72; if you borrow £300 for 30 days, you pay back £394.60. Yet this doesn’t seem like a “2689% APR”, does it?

If you buy a 32” Toshiba LCD TV from Argos, at £300 under their “Buy Now, Pay 9 Months Later” scheme, the APR is 29.9%, which sounds so much cheaper than the 2689% that Wonga quotes.

Wonga’s website is very useful in explaining the informational failure problem here. It explains why APR is not the correct measure to use when looking at short term loans. The common perception that a higher APR means a more expensive loan is not always correct.

This is because the cost of a Wonga loan depends on the amount of money borrowed and the number of days you need it for - the shorter the term, the less you’ll pay in interest and fees. Which is just like any other loan, BUT the calculated APR figure actually increases as the term and cost of a Wonga loan decreases. The reason is that when you calculate APR, as the loan period gets shorter, the more times you have to multiply and compound the interest to make it into a theoretical annual APR figure!

If you borrow £100 for 5 days, the APR is 3253%; if you borrow it for 15 days its 2773% and if you borrow it for 20 days, the APR is 2573%.
It may be a bit strange then that Wonga openly advertise on their homepage that the APR for loans is 2689% - but it’s a clever bit of marketing actually – as quoting APR is a legal requirement in many countries including the UK and US, and so clearly it is better to be proactive in pointing out the size of it being “crazily high”, rather than shying away from it. And actually grabs people’s attention enough for them to write Facebook statuses on it, and blog entries!

Caveat emptor! - I’m not saying that Wonga is a bargain or offering financial advice here, but the point is that an APR figure in and of itself does not give you enough information about whether a loan is a bargain or not, unless the loan durations are of any meaningful length.

Wonga.com lends money for SHORT TERM durations – so you never actually “pay” the 2689% APR – It’s a theoretical figure derived from the terms of the short term agreement. Not only does this mean you should use a bank for longer term loans, the point is you have no other option as Wonga doesn’t do long term loans. Although, it has an interesting “Trust Rating” system (akin to microfinance schemes in the developing world) where if you pay off small loans (max. £400) with no problems, then you earn “trust points” which mean you bridge the asymmetric information bridge and show yourself NOT to be a lemon, and of good creditworthiness, thus being permitted to borrow higher amounts.

Given Fergie’s financial woes, I wonder if she will be interested in this blog entry…

Unit 2 Macro: Cyclical and Structural Economic Issues Facing the UK [23 May 2012]
Unit 2 Macro: Evaluation on Supply-Side Policies [21 May 2012]
Unit 2 Macro: Migration and the UK Economy [20 May 2012]
Unit 2 Macro: The Output Gap [20 May 2012]
Revision notes on unemployment [20 May 2012]
Unit 1 Micro: Revision Presentation on Government Intervention [16 May 2012]
Unit 1 Micro: Revision Presentation on the Price Mechanism [16 May 2012]
Improving Evaluation Skills in Economics Exams [16 May 2012]
Unit 4 Macro: African Human Development Report 2012 [15 May 2012]
Unit 1 Micro: Economics of a Minimum Wage [12 May 2012]
Unit 1 Micro: Revision Blogs on Markets and Intervention [10 May 2012]
Unit 3 Micro: The Dawn of a Shareholder Spring? [8 May 2012]
Unit 2 Macro: 10 Key Revision Topics for EdExcel [7 May 2012]
Unit 2 Macro: Monetary Policy and Inflation Glossary [5 May 2012]
Unit 2 Macro: Fiscal Policy Glossary [5 May 2012]
Exam Technique for Economics - Weesteps to Evaluation [5 May 2012]
Macro Revision - Key Statistics on the UK Economy [4 May 2012]
Robert Schiller - Finance and the Good Society [1 May 2012]
Unit 1 Micro: Using the Cost-Benefit Principle [30 Apr 2012]
Macro Revision: Putting Things in Context [29 Apr 2012]
Unit 2 Macro: Britain back in Recession [29 Apr 2012]
Unit 4 Macro: The Euro Zone Crisis (Revision) [22 Apr 2012]
Unit 1 Micro: Adecco and Monopsony Power [22 Apr 2012]
Unit 3 Micro: Key Diagrams for Business Economics [17 Apr 2012]
Unit 4 Macro: Managing the Global Commons - Limits to GDP [15 Apr 2012]
Unit 4 Macro: Mini Documentary on Financial Instability [15 Apr 2012]
Ukraine Hotel ‘Bandits’? [12 Apr 2012]
Government Intervention in the Energy Market [11 Apr 2012]
Football Clubs to Pay for Negative Externalities [11 Apr 2012]
2012 Economics Revision: Ways to Improve your Paper [9 Apr 2012]
Unit 4 Macro: Evaluating 3 Years of Quantitative Easing [27 Mar 2012]
Unit 1 Micro: The Tax on Beer [16 Mar 2012]
Unit 4 Macro: Video Resources on the Euro Crisis [10 Mar 2012]
Unit 1 Micro: Highest and Lowest Paid Jobs in the UK [26 Feb 2012]
Unit 3 Micro: Low Pay in Supermarkets [24 Feb 2012]
Unit 4 Macro: King on the UK Economy [15 Feb 2012]
Unit 1 Micro: Public Goods [11 Feb 2012]
Martin Wolf on Global Shocks [10 Feb 2012]
Competitiveness [8 Feb 2012]
Trucks are the new way of measuring debt [1 Feb 2012]
Unit 2 Macro: Growth and Development - Some Indicators [30 Jan 2012]
Unit 1 Micro: Can the UK Computer Games Industry Grow [24 Jan 2012]
France and Flexible Employment [22 Jan 2012]
Teaching vacancy - Economics & Business Studies, Reed’s School - Cobham, Surrey [19 Jan 2012]
Unit1 Micro: Can a minimum wage create jobs? [16 Jan 2012]
Unit 4 Macro: France loses her AAA credit rating [15 Jan 2012]
Unit 4 Macro: Economics of Fiscal Deficit Reduction [12 Jan 2012]
Unit 4 Macro: UK Bond Yields Reach Record Lows [11 Jan 2012]
Revision Presentation: Economics Evaluation Skills [10 Jan 2012]
Exam Advice: 10 Ideas for a Better Economics Paper [10 Jan 2012]
Unit 2 Macro: Factors Driving Business Investment [10 Jan 2012]
Economics at the Movies - Freakonomics [9 Jan 2012]
Unit 4 Macro: Natural Disasters and their Economic Impact [7 Jan 2012]
AS and A2 Economics - 10 Ways to Improve Evaluation [4 Jan 2012]
Unit 1 Micro: Prezi on the Economics of Negative Externalities [2 Jan 2012]
Resources on Keynes and Hayek [27 Dec 2011]
2011 in Review - The US Economy [27 Dec 2011]
Unit 2 Macro: The UK Housing Market in 2011 [26 Dec 2011]
The Eurozone Crisis Explained (again!) [22 Dec 2011]
Introduction to Neuroeconomics - Fusing Psychology with Economics [16 Dec 2011]
Rory Sutherland at Zeitgeist [1 Dec 2011]
Behavioural Economics: Herd Behaviour [28 Nov 2011]
Stephen King - Great Article on Macroeconomics [22 Nov 2011]
Beyond the Bike - The Value of Money [19 Nov 2011]
LSE Lecture: Daniel Kahneman - Thinking Fast and Slow [15 Nov 2011]
Unit 2 Macro: Should the EU introduce a Tobin Tax? [14 Nov 2011]
LSE lecture: Darwin economy [13 Nov 2011]
AS Macro: The State of British Business [13 Nov 2011]
Eurozone crisis - a selection of resources [12 Nov 2011]
Economics Resources - Week Ended 6 November 2011 [6 Nov 2011]
Unit 3 Micro: Time of Use Pricing for Energy [2 Nov 2011]
Unit 4 Macro: Should TNCs make full disclosure on factory wages? [30 Oct 2011]
Unit 3 Micro: UK Executive Pay - All in it Together? [29 Oct 2011]
Is happiness the right measure of social progress? [20 Oct 2011]
Unit 3 Micro: Drop Box and Freemium [18 Oct 2011]
Can the “invisible hand” solve Africa’s poverty? [13 Oct 2011]
Unit 4 Macro: Unit Labour Costs and Inflation [12 Oct 2011]
Skidelsky in Madrid [12 Oct 2011]
Why Is Macroeconomics Such A Mess? [11 Oct 2011]
Fat tax: Denmark [5 Oct 2011]
Unit 3 Micro: Monospony Power and Low Wages in Care Homes [3 Oct 2011]
Unit 3 Micro: Tube Drivers set to earn £50,000 a year [3 Oct 2011]
NMW: Classical real-wage unemployment [3 Oct 2011]
Greek debt decision tree [25 Sep 2011]
Unit 4 Macro: Greek Economy at Default’s Door [25 Sep 2011]
Unit 4 Macro: IMF Flags up Risks of Double Dip [20 Sep 2011]
Unit 2 Macro: Economic Growth and Inequality [14 Sep 2011]
Unit 2 Macro: Income and Wealth in the UK [12 Sep 2011]
Starter Video: The Slums of Manilla [11 Sep 2011]
50% tax rates - Chuck it George [7 Sep 2011]
NHS spending good, private provision bad? [5 Sep 2011]
Mixing with the Nobel Economists [4 Sep 2011]
Toilet rolls, soap and climate change [1 Sep 2011]
John Kay on the future of Economics [26 Aug 2011]
Unit 4 Macro: GDP per person since the credit crunch [19 Aug 2011]
Unit 1 Micro: The Price of Football [2 Aug 2011]
Unit 4 Macro: Dangers of High Inflation [11 Jul 2011]
Unit 3 Micro: Oligopsony - Dairy Losses Drive Farmers from the Fields [10 Jul 2011]
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