Payday loans are high-interest short-term loans, usually over a period of two weeks. One recurring political...

Payday loans are high-interest short-term loans, usually over a period of two weeks. One recurring political question is whether or not interest rates on such loans should be capped. Roughly speaking, those in favor of caps want to protect consumers from potentially harmful loans, while those against caps want to let the free market determine what the rate should be.

First, do you think there should be interest rate caps on payday loans or not? Defend your answer. Also, determine the interest that would be charged on a two-week $300 payday loan if the interest rate is 520%, and the interest is compounded at the end of the two weeks. Explain how you came to your answer. Finally, suppose a friend or family asked you how it could be possible that an annual interest rate is higher than 100%. Write out an explanation of what you might say to them.

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Expert Solution

Payday loan interest rates should be capped because people most impacted by these higher interest rates are the ones most vulnerable people of the society without any option. The way we have minimum wage to ensure that workers at lower levels are not exploited, the same way, a case can be made to cap the interest rate for payday loans. In addition to higher interest rate, there are exorbitant and exploitative finance charges and once the borrower enters into vicious cycle of non-payment and subsequent charges, there is no escape. These payday loans have ruined many lives and families and it’s high time to cap the interest rates.

Annual Interest rate = 520%

Interest charged on a two-week (14 days) loan = 520% X (14/365) = 19.95% or 20%

Hence, Interest Charged = 20% of $300 = $60

Annual interest rate can very well be higher than 100% and it all depends on the rate being charged and the frequency of compounding.

For example –

- A 10% monthly interest rate without compounding amounts to 120% (12*10%) per annum which is above 100%

- A 10% monthly interest rate with monthly compounding amounts to 214% (i.e. (1.1) ^12 – 1) per annum which is well above 100%

jeff jeffy answered 1 year ago

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