Question

Part 1: The typical payday loan comes with a fee of $15 for every $100 borrowed and is due in two weeks. Assume you borrow $100 under these terms: $15 fee and two-week maturity. What is the APR of the loan? What is the EAR of the loan? What accounts for the difference between the APR and EAR?

Part 2: Should the government regulate payday loans? Why or why not? If payday loans are legal, should private companies restrict access to them? Why or why not? Find and cite at least two articles to support your arguments.

Answer 1

Part 1:

Prinicpal amount = $100

Interest amount = $15

Repayment term = 14 days ( 2 week)

Calculation of APR

​APR=(((Interest/ Principal​​)/Repayment term)×365)×100

APR = (((15/100)/14)​ *365)*100

= ((0.15/14)*365)*100

= (0.0107*365)*100

= 3.910*100

APR= 391%

Calculation of EAR

EAR = ((1 + (Interest rate/Compounding Periods))^Compounding Periods)-1

Interest Rate = 15% ( as calculated above)

Compounding Periods = 365/ Repayment Period = 365 /14 = 26.07

EAR =(((1+3.91/26.07))^26.07)-1

= (((1+0.146))^26.07)-1

= ((1.146)^26.07)-1

= ((1.146)^26.07)-1

= 330%

  

Difference between APR and EAR

APR is based on simple interest, while EAR takes compound interest into account. APR is most useful for evaluating mortgage and auto loans, while EAR is most effective for evaluating frequently compounding loans such as credit cards.

Part 2 _ Government should regulate Payday loans because

Payday loans are marketed as a stopgap, with the consumer expected to repay the loan when they receive their paycheck. What often happens, however, is much different: Instead of paying back the loan in full, consumers find themselves scrambling to manage the loan repayment and other bills. Soon the principal balloons and the consumer gets into a huge debt trap.

Government should have regulations to avoid consumers falling into abusive lending practices.