Payday lenders are calling for all loan providers to spell out their costs in pounds and pence after finding widespread confusion among consumers when charges are given as an annual interest rate.
Less than one quarter of people surveyed by the Consumer Finance Association (CFA), which represents short-term lenders, could identify the correct answer when asked to calculate the cost of borrowing £100 for a month using the financial services industry's standard APR (annual percentage rate) calculation.
The CFA said the use of APRs means the payday industry has come in for "unfair" criticism for charging annual interest of thousands of per cent, when in reality the average cost of a payday loan, which is intended to last for a few weeks rather than a year, is £25 per £100 borrowed.
The trade body, which represents 60% of the UK's payday industry, wants to see more loan providers spelling out borrowing costs in cash terms as well as APRs, as its members already do.
Nearly three-quarters (72%) of more than 2,000 consumers surveyed for the CFA thought they would be able to compare borrowing costs more easily on financial products if all charges were set out in pounds and pence.
Those who took part in the CFA's survey were asked how much they would pay back if they borrowed £100 for a month through a short-term loan with an APR of 1,355.2%.
Just 24% of people surveyed by the CFA selected the correct answer of £125, while nearly a third (28%) thought it would cost £1,355.20.
Around one in 10 of those who took part in the research had taken out a payday loan in the past.
Russell Hamblin-Boone, chief executive of the CFA, said: "Borrowers should not confuse APR with the actual interest rate, the most important thing to know is the total cost of the credit."
He said that a more "level playing field" to help consumers compare costs would be created if all loan providers were required to give the full cost of a loan in pounds and pence.
Mr Hamblin-Boone said the payday industry has been "unfairly criticised" for its APRs, adding: "No one ever pays back thousands of per cent in interest, on a short-term loan.
"Quite simply, the average charge is £25 per £100 borrowed. APRs associated with payday loans are often the focus of negative comment and discussion, however, a high APR does not mean it is the most expensive form of borrowing, the length of loan affects the APR figure; shorter loans have higher APRs since APR is based on a 12 month period."
The payday industry has come under heavy criticism for high borrowing costs, and much of the focus has been on the APRs lenders are required to advertise, which often run into thousands of per cent. The APR advertised by Wonga, one of Britain's best-known payday firms, for example, is 5,853%.
Wonga also displays its costs in pounds and pence to borrowers and says that it charges 1% simple interest a day, so a 15-day loan would cost an interest rate of 15%.
Payday firms' practices are currently being investigated by the Competition Commission, after a damning report by the Office of Fair Trading found "deep-rooted" problems in the sector, including people being granted loans which they cannot afford to pay back. The loans are then rolled over and the original borrowing costs rapidly escalate.
Almost half of 50 payday lenders who were ordered by the OFT to prove their practices were up to scratch have decided to throw in the towel.
The CFA's research found that people also found APRs hard to understand when applied to products such as mortgages.
Just one in six (15%) of those surveyed correctly identified that a £200,000 mortgage over 25 years with an APR of 7% would cost them twice as much as the original amount borrowed eventually, according to the findings.
The CFA said that younger people tended to have a higher awareness of the actual cost of a payday loan. When asked how much the average monthly interest is on a £100 loan from a payday lender, a quarter of 16-24 year olds correctly answered between 25-50%, while just 15% of 45-55 year olds made the right selection.