Actually, one might wonder why this type of loan exists. Loans with such high interest rates should really be described as useless, and be banned.
In my opinion, this is a classic “attack claim” that many people use without explaining in detail what they mean and what capital costs it is about. With a 40% annual interest rate, the writer seems to assume that 40% of the loan amount must be paid in capital cost – and thus best! The cost of a USD 5000 loan is thus considered to be 5000 x 0.4 = USD 2000. EXACTLY I think people reason.
Which is wrong.
An SMS loan is not a long-term loan
An annual interest rate of 40% would, for a USD 5,000 annual loan using annuity, provide a installment plan that looks like the following. The accumulated interest rate is marked and constitutes the total cost of capital over time.
Even if you lend out the entire period, you will therefore pay a maximum of USD 1148 , ie almost half as much as you might have thought you would pay. Because you amortize. You can also redeem the loan in advance at no extra cost. Since small consumer loans are often temporary (until pay?) It costs USD 167 if you only want to borrow the money for a month.
How many would have screamed an upset “no!” If we asked the question: “Is it acceptable to pay USD 167 to borrow USD 5000 for 30 days in an acute but temporary situation?”
Annual interest rate from a business perspective
- Borrowing 100,000 gives a company interest income of USD 3333 in the first month.
- Borrowing 5,000 gives the company interest income of USD 167 in the first month.
The administration is the same – so why is it so difficult to understand that small amounts demand a high interest rate while larger amounts can be offered at lower interest rates?
SMS loans are, as we mentioned, short-term. Although the 12-month loan arrangement can be convenient due to the extra deadline, there is nothing to prevent the lender from putting up the loan for a shorter maturity, eg. 3 months with retained annual interest rate. It would look like this:
In the following example, we pledge with an annual interest rate of 2.95% to contribute with something ridiculously low. This is an interest rate that, understandably, cannot be obtained if you do not need a really large loan, ie something completely different from a temporary loan – but we still count!
Is it likely that you, as an entrepreneur, would offer this at a profit of USD 80.26 for 12 months before you even deducted your own costs? Would not believe it. It is simply not a functioning business.
But by all means – let’s say we created a fictitious company with 2.95% annual interest rate for a loan of USD 5,000. A fictitious but likely setup fee of (at least) USD 295 would certainly not create any headlines in the newspapers. No wonder about that – it’s actually a cheap loan with a very safe cost trend.
This fictitious loan is not an obvious best choice for those seeking a temporary smaller loan:
It will be more expensive than the scorned loan with a 40% interest rate – for 2 months. And that’s the thing with sms loans: short-term, fast, temporary!
So sure, 40% annual interest rate is a fully affordable interest rate when it comes to sms loans if you take into account both the customer and the lender’s needs.