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

Question

3. 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 lemons 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 lack of asset of poor people causes high rate of interest is the lender is lending money without any security therefore, he is bearing risk more than any bank. Hence the higher interest is the reward of higher risk bearing.

b) the lenders won't prefer to give loan to them then. Rather they would prefer to give it to someone with good credit history and asset.

Related Questions

Navigate

• Browse (All)
• Browse 3
• Subjects

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