This morning, I spent some time on Quora.com, and found a question about legally abolishing high interest rates. I wrote an answer:
This is a real bugbear for me.
High interest rates, over short periods of time, are not so ‘unaffordable’ when the time period is short.
- Let’s say that you try and charge me an interest rate of 100%.
- Terrible, right?
- Only, on a daily basis, that works out to 0.27% interest per day.
I’m not saying that’s not high – but if I reframed this as “I’ll lend you R10 today – and tomorrow, pay me back R10 and 3 cents”, then you might find that reasonable.
More problematically though, what we forget is that any loan transaction actually has two parts:
- Compensating the lender for the use of their money; and
- Compensating the lender for getting out of bed in the morning and taking a risk with their money.
When the loan amounts are large, the compensation for getting out of bed in the morning is negligible. But once you start hitting these small loan amounts, that second part becomes problematic.
Here is a payday loan quote that I got this morning from a UK lender:
So that’s really high, right? An interest rate of 292% per annum. But because of the way that the UK’s financial legislation works, that figure includes both the cost of the money being borrowed and the fees associated with putting that loan together.
Here in South Africa, our National Credit Act requires us to split out the fees from the interest. So here’s a quote from that same lender, just here in SA:
So to summarise the important parts:
- Where costs are not split out, the interest rate per day is 0.8% (or 292% per annum).
- Where costs are split out, the interest rate per day is 0.1% (or 36.5% per annum).
And/or if we look at that South African payday loan, we can split that R419.60 of ‘interest and fees’ into:
- R370.50 of fees, and
- R49.10 of interest
Unfortunately, there is no easy legal solution – but I think that there is a communal solution: lending clubs. Or stokvels. Or susus.
And here’s why:
- Fees are eliminated, because there’s not the same regulation around informal lending clubs, and the members’ have a vested interest in keeping the capital safe.
- The lending club can actually charge its members high interest rates (because those aren’t the dramatic cost involved in payday loans).
- And the club members can collect the interest from their borrowing members as a return on the members’ money (instead of the interest going to loan sharks).
In short: everyone saves (because no one pays fees) and everyone wins (because the interest charges go to the members instead of going to the payday lender).