Time Value of Money Applications

A payday loan is a small, unsecured, short-term loan ranging from $100 to $1,000 (depending on the state). Borrowers simply write a personal post-dated check for the amount they want to borrow. A flat fee of $15 for every $100 borrowed is usually charged. The fees on such loans can equate to an annual interest rate of over 390%. Some argue this is an outrageous rate.

On the other hand, the costs of these loans can be less expensive than the other costs the borrowed funds are being used to avoid. For example, the $15 fee might be used to get $100 to avoid a $30 check overdraft charge, a $40 late credit card payment fee, or a $90 charge to reconnect electricity service, which will be disconnected without the money to make the electric payment.

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A manager at a payday loan and check cashing business defends his company’s business practice as simply “charging what the market will bear.” “After all,” says the manager, “we don’t force people to come in the door.”

How would you respond to this ethical defense of the payday-advance business?

Time Value of Money Applications

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