According to the story by
Susan Tompor, Michigan’s Attorney General has just announced a settlement following
legal action against two out-of-state lenders who had been offering short-term
loans at rates ranging from 89% to 169% interest, or between 12 and 24 times
the State limit for unlicensed lenders of 7%. The story notes that under such a
loan a consumer who borrowed $1,000 for a two year period would end up paying
over four times what they borrowed. Even worse, however, was a much shorter (six-month)
loan program with an effective APR of over 350% - effectively, paying $1.75 for
each dollar you borrowed in addition to
repaying the full amount…
It’s not always clear why
people agree to loan terms like these. In some cases it really is desperation –
the need to pay off some expense that can’t be financed any other way, and for
which default (or foreclosure) isn’t an option. In other cases it’s a matter of
speculation – the belief that the customer can take the money, buy something,
sell it quickly for more money, and pay back the original loan before the
interest has a chance to add up. You will see this kind of thing happen any
time there’s an investment bubble in play – we saw it in 2005-2008 in the Real
Estate Bubble, around the turn of the Century with the Dot-Com Crash, even
during the Beany Baby craze in the late 1990s. But the sad truth is that many
of these loans result from the fact that most people don’t really understand
how finance actually works…
Now, we should probably
acknowledge that loans of this type do represent a large risk for the lender.
Generally unsecured by anything, and frequently take out by people who lack
either the assets or the income that would make it worth taking them to court,
a disproportionately large number of these loans will end up in default, and
the company will never recover any of the money. Consequently, the interest
rate on these loans has to be high enough to make up for the increased risk, or
no one would ever offer them in the first place. Unfortunately, that’s also
where and why the whole topic moves into the grey area…
If the state imposes a hard
limit on the interest that can be charged for unsecured loans (in Michigan that
limit is currently 7%) then there is also a hard limit on how risky the
individual loans can be. If the lender can only make 7% on its money, and more
than 7% of its funds are never repaid at all, it will quickly go out of
business. Such a policy will prevent people from being charged 169% interest on
a loan, but it will also keep someone with an 8% chance of defaulting from
getting a loan. Predatory lending appears in the first place because there are
people with a (real or perceived) desperate need for funds who can’t qualify
for an ordinary loan – and as long as that need exists, there will always be
unscrupulous companies who will be willing to risk state and Federal sanctions
to make a fast buck…
Unless we can manage to educate
the public about how finance works, or at least about how consumer loans do,
this situation is probably going to continue. Alternately, I suppose, we could
try teaching people about saving money, living on a budget, and not blowing
money on get-rich-quick schemes or inappropriate purchases. In either case,
however, I would not recommend holding your breath…
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