Understanding the Hidden Costs: 'Easy' Online Loans

There are many online apps that provide people with "easy" loans.

If you look at the fine print, you will find that the average interest rate is 0.8% per day. Now, what does that mean?

A simple individual might think that this interest rate is very low, but it's a trap. Remember that in the world of finance, interest rates are always calculated on an annual basis. If someone is quoting an interest rate on a monthly or daily basis, it will be much higher than the stated annual interest rate.

Without delving into too much complexity, currently, traditional banks have interest rates of around 25% annually for consumer loans. Since compounding is done on a daily basis, in reality, you have to pay about 28% interest per year. This means that if you borrow one lakh (100,000) rupees, you will be obligated to pay the bank 128,000 rupees after one year.

In comparison, consider the "easy" loan scheme. If the interest is calculated separately on a daily basis, then 0.8% in exchange for one lakh rupees means 800 rupees per day and a total of 292,000 rupees in interest over the course of a year. This means that the total amount to be paid back after one year will be 392,000 rupees. The interest rate is 292%.

If by some stroke of luck someone manages to get a loan at a rate of 0.3%, the effective interest rate would still be 109%, meaning you have to pay back 209,000 rupees in exchange for 100,000 rupees after one year.

And if compounded interest is charged at 0.8% per day, then you can't even imagine how much interest will accumulate. The compound interest formula shows that it would reach a rate of 1732%. Therefore, we keep it aside. Although it is rare to apply this rate to short-term loans, it is not impossible to collect interest at this rate. It means 1 rupee would accumulate 1732 rupees annually.

So, in short, here's the comparison:

Bank's annual interest rate: 25%

Bank's effective interest rate: 28%

App's daily interest rate: 0.8%

App's effective interest rate: 292%

Be cautious and don't get caught in the trap of these "easy" loans.