Question

Payday loans (Links to an external site.), a cash advance on a person’s paycheck, are a form of credit that only require income and a bank account. The borrower typically agrees to pay a fee, which acts like an interest rate, to the lender and is required to repay the loan at the time of his or her next paycheck. Recently, the government and private companies have added to the debate over payday loans.

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

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Part 1 Solution :

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 actually is based on the simple interest basis, while EAR takes the 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 Solution :

Government should regulate Payday loans because of the following reasons :

Payday loans are advertised as a band-aid, with the shopper expected to reimburse the credit when they get their paycheck. What regularly occurs, and notwithstanding, is much as various: Instead of the taking care of the credit in full, the buyers get themselves and scrambling to oversee advance reimbursement and furthermore different bills. Very Soon the chief inflatables and the purchaser gets into a gigantic obligation trap.

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