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Payday loans are often criticized because the lenders target the poor and the young who have no knowledge about the time value of money. The time value of money (TVM) is also known as the “discounted present value”. It is considered as one of the basic concepts of finance developed in 1202 by Leonardo Fibonacci.

The TVM is based on the idea that a person will prefer to receive a certain amount of money today than to receive that same amount tomorrow or at some time in the future. A $100 can be used to buy several things today, but after a year, this $100 may not no longer be capable of purchasing the same things, and in five years, the same $100 could be considered worthless. The lesser capacity may be due to inflation and other economic factors. In other words, a $100 today is far more valuable than the same $100 next year. This is why money that is deposited in the bank must earn interest.

The future value of a certain amount of money can be computed using the compounded interest formula. For example, the annual interest rate of money is set at 20%. This means that after one year, the value of $100 today will be equivalent to $120. And after another year, the equivalent value becomes $144. If we project the money farther into the future, the value of a $100 today, at 20% annual interest, after five years will be $248.832. Of course, if the interest is lower, perhaps 5%, the value in five years will also be lower.

With payday loans, however, the annual interest could range from 180% to 420%. This means that the lender is projecting a $100 to be worth $280 next year. This is obviously an exaggeration. Money values could not inflate that much and that fast. And when viewed this way, getting a payday loan is indeed considered a bad financial move. This is one of the foremost criticisms against payday loans.

Yet, the interest charged by payday loans is definitely lower than bank charges for bouncing checks. And these loans do meet the needs of people who find themselves in a cash flow gap. Also, Payday loan lenders have one strong reason why they charge high interest rates. If they utilize the usual or conventional interest rates, they will earn lower amounts.

For example, if they charge only 20% annual interest (instead of the 180%) and even compounded weekly for a one month loan, the interest would be about $0.38. This amount cannot cover their operational expenses and the cost of processing the loans. Payday loan lenders will be in worse shape compared to any other company on a shoe-string budget.

John Mussi is the founder of Direct Online Loans who help homeowners find the best available loans via the http://www.directonlineloans.co.uk website.