Various levels of government have expressed various levels of concern over the cost of consumer debt.
In the area of credit card interest some have proposed caps on the interest rate that credit card companies can charge.
The latest, in British Columbia is to regulate the payday loan industry to a maximum of 23% on short term loans of, for example 2 weeks.
These are examples of nanny rules to protect individuals from making stupid decisions.
In my view a preferable role of government is simply to ensure that accurate and relevant information is provided to consumers.
Take the payday loan as an example.
If the loan company says "you pay 23%" a reasonable individual may think it a little high but not unreasonable relative to credit card interest of about 24%..
The startling truth of the matter is that the real annualized rate of interest on a 14 day payday loan with a 23% fee is 21,653% while a credit card at 2% per month is 26.8% annualized.
As an aside the press reports the annualized payday rate as simply 26*23%=600% but that ignores the aspect of compounding. If the individual borrowed $100 and rolled over the loan each 2 week period then at the end of the year the debt would be $21,753. Now that might give pause to the wisdom of borrowing at what is an annualized rate of 21,654%. And the converse is that if the payday loan company lends $100 and continually rolls over its cash flow into extending or new loans then at the end of the year it will have $21,753.
So what should be the role of a non nanny government.
They should insure that the effective annualized rate of interest is quoted prominently in all contracts and in all advertisements.
If someone wants to buy money at a price of 21,654% interest rate then who is the government to pretend that their cap on fees at that rate has somehow given them some protection from a stupid move.
The illustration is copied from elsewhere and the specific numbers do not relate to my calculation. The general impression from the illustration is fair.
All this suggests a topic for a future blog. Why We Need to See Financial Calculators in Schools as Well As Scientific Calculators.
You seem to think it was wrong for the government to limit payday loans to 23%. The loan serve a purpose for small loans with little red tape. The loan companies are in business surely you do not want to shut them out of that market. That 21,654 interest rate must be wrong. I saw a editorial in the Sun I think they said 600% but did not see anything wrong with that. Are you serious.
ReplyDeleteYes I'm serious. The correct annualized interest rate is 21,653%. I don't want to shut them out of the market--- just make it clear and obvious the rate of interest in the contract. Yes it was the Vancouver Sun about March 3 that an editorial mistakenly equated the 23% for 14 days to 600% for a year. If you are mathematically inclined think of the rate of interest as the first derivative of debt with respect to time. A standardized way of quoting rate of growth is important. I think of the time I was stopped for speeding just as I left my house. I guess I could have said "but officer I cannot possibly have been going 60km per hour as I have only been traveling for 10 minutes". 60km per hour is a rate of speed. 21,653% is a rate of growth.
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