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Zer Netmouse
February 3rd, 2009
07:12 pm

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Do You Believe in Usury?

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From:nicegeek
Date:February 4th, 2009 02:03 am (UTC)
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"At what range do interest rates charged on borrowed funds start to seem excessive to you?"

I don't think this one can have a simple answer; interest rates compensate the lender against the chance of the borrower defaulting, so they have to be viewed in light of the length of the loan, the borrower's history of paying their debts responsibly, whether there's any collateral, and what the current macroeconomic conditions are.

"Do you think governments should have usury laws defining specific limits as to what interest can be charged?"

Interest rate limits are a two-edged sword. Their intent is to keep "predatory" lenders from taking advantage of people who don't know what they're getting into. However, their side-effect is that people who might have only been able to get loans at a rate above the limit will not be able to get loans at all. While this keeps some irresponsible or uneducated people from taking out loans that they would not have been able to afford to pay back, it also makes it harder for those who have tarnished their credit history to get second chances from reputable lenders, which pushes them toward shady dealers where the late fees aren't just monetary.

Given the above, I think it's probably better not to limit interest rates. Having the rates be legal means that there will be more lenders for the borrowers to choose from, which puts them in a stronger bargaining position. However, it's critically important that they be educated enough to shop around for their loans. I also think that it would be appropriate to ban lending clauses that penalize early prepayment, since these serve to lock the borrower in if they later find a better deal.
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From:netmouse
Date:February 4th, 2009 02:13 am (UTC)
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I agree with you with regard to prepayment penalty clauses past a reasonable minimum processing time to keep paperwork/processing costs down (reasonable to me is 2 or 3 months).

I have to admit, I wonder if there's not an interest rate that actually raises the chance that someone will default on a loan, i.e. "take the money and run" rather than pay such an expensive loan back.

But, seriously, you don't have a problem with it if someone is charging 45-75% interest on a loan?

From:sethb
Date:February 4th, 2009 02:53 am (UTC)
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75% interest can be quite reasonable. Suppose you're borrowing the money to do some business, and there's a lot of risk that you'll fail and not repay. The high interest rate is effectively an equity participation. And if the term of the loan is a month, 75% annually isn't that many dollars.
From:nicegeek
Date:February 4th, 2009 02:57 am (UTC)
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"I have to admit, I wonder if there's not an interest rate that actually raises the chance that someone will default on a loan, i.e. "take the money and run" rather than pay such an expensive loan back."

There probably is, but that actually argues against the need for a cap, since charging too high a rate would be self-defeating.

"But, seriously, you don't have a problem with it if someone is charging 45-75% interest on a loan?"

The counter-question is "Why is the borrower considering taking a loan at that high a rate?" If it's because a lender is charging them a higher rate than they could get elsewhere, a public information campaign would be a more appropriate solution to teach people to shop around. If it's because the administrative costs and default risk of the loan actually make that high a rate necessary, then the alternative is for the person to get no loan. While that might be better in some cases, there are numerous examples, of such loans doing a lot of good, especially in third world countries.

Take the case of CompartamosBanco, a lending institution in Mexico. It charges rates in that range and higher. However, it makes tiny loans to people with no credit history (and often no bank accounts) in remote villages, so that they can start businesses. If it was constrained to interest rates such as we see in the U.S., these people would never get loans at all, save by the grace of charity. But because it can lend profitably, CompartamosBanco lets them get their businesses started, and other lenders are moving in, causing competition to start to push the rates down.

There was a similar surge of microlending a while ago in South Africa, but the government capped rates and killed the industry.

From the research paper's conclusion:

"The interest rate ceiling produces a series of adverse effects. They cause charges to drift up to the ceiling and they also encourage illegal lending. Instead of regulating interest rates a more effective approach to ensure that the rates charged by micro lenders are appropriate is to encourage competition. This will spur innovation aimed at reducing the risks and costs associated with micro lending."
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From:netmouse
Date:February 4th, 2009 03:20 am (UTC)
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Huh. The South African cap was defined as a multiple of their prime rate according to the paper you reference. An interest cap defined as "ten times the prime rate" is tremendously sensitive to the order of the prime rate. If the prime rate is 1 percent, the cap is 10%, but if the prime rate is 10% the cap is 100%. The paper argues the micro-loan short term (0 - 6 month) lenders needed a 30% interest rate in order to be profitable, but they do not discuss what the actual interest rate cap was during that time.

There is a reason why the "group" microloan system in Bangladesh won the Nobel prize. There are other ways to reduce risk apart from charging higher interest rates.
From:sethb
Date:February 4th, 2009 02:51 am (UTC)
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There should be a time limit on prepayment penalties, perhaps as a function of the loan's length (so a 1-year loan might have a 1-month limit, but a 30-year mortgage could have 2 years). (Otherwise, the lender is just going to charge more upfront to cover the costs and risks of early prepayment, and that's bad for the borrower for several reasons, including taxes.)
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