A number of companies exist that specialize in \"payday loans.\" Payday loans ar

Question

A number of companies exist that specialize in "payday loans." Payday loans are small loans often for a few hundred dollars or less that are made to low-income borrowers. Often these borrowers have poor credit histories and few assets and would have difficulty in qualifying for loans from other sources. The interest rates on these loans are often very high and some commentators have suggested that ceilings should be enforced on these loans.

a.Try to apply the lemon’s problem to the market of payday loans and explain what causes the high interest rates in this market.

b.If such interest rate ceilings were imposed, what would be the likely effect?

Explanation / Answer

A- The lemon problem refers to issues that arise due to asymmetric information possessed by the buyer and seller of an investment or product, regarding its value . Same it goes for Above case that the Borrowers have poor credit history. These lenders has asymmetrical and these borrowers know the true position of themselves. However these small Pay day loan companies doesn't have this knowledge, since they are not privy to all the information about borrower.So these small loan companies don't have such information about borrowers therefore they are willing to offer these loans at higher rate which is somewhere between bargain price and premium price.This higher interest amount will provide these companies with aome degree of financial protection from the risk of lending money to such customers with poor credit history.

Causes of high interest :

-They charge for cost of unpaid debts and service charges

-They search for financial viability

-Money cause them too

-High operating costs

Part B- Imposing interest ceiling leads to

-Shortage in credit supplied to market

-Less transparency about the exact cost of the credit in the pay day loan companies

- Limiting the scope of operation of these companies.

-Losing the chances of obtaining the loans for underprivileged class in the society.   

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.