Crazy Calculations
The FDIC insures all our checking and savings accounts, but they apparently don’t understand interest. The Truth-in-Lending law they administer has been interpreted so that uniformly-reported “annual percentage rates” do not compound within each year. The key portion of the regulations specifies instead that periodic rates should be multiplied by the number of periods in a year to get the APR.
For most types of consumer credit, including credit cards, this makes little or no difference or other regulations fix the problem. One realm, however, where it leads to allowance of very misleading advertising, is the case of payday loans. The typical payday loan carries a finance charge of 18% for a two-week loan. The FDIC’s guidelines imply that this loan has an APR of 26*18% = 468%.
The more relevant calculation, which yields the true cost of this form of liquidity to consumers and is the right number for comparisons with most alternatives, is (1.18) to the 26th power minus 1, which yields a whopping 7295%.
