41 TAKE AN INTEREST IN YOUR INTEREST

Adam Smith states, ‘The man who borrows in order to spend will soon be ruined, and he who lends to him will generally have occasion to repent of his folly. To borrow or to lend for such a purpose, where gross usury is out of the question, [is] contrary to the interests of both parties.’

The key here, of course, is ‘where gross usury is out of the question’. In Smith’s time, the law tried to prevent usury by fixing the highest rate of interest allowed without penalty. Today, usury is commonplace, not just by those sporting a menacing stare and a baseball bat! Pinstripe suits and corporate respectability are also in on the act.

DEFINING IDEA…

Man was lost if he went to a usurer, for the interest ran faster than a tiger upon him.

~ PEARL S. BUCK, WRITER

At one end of the social spectrum you have people like Gerard Law, No. 1 loan shark in the deprived Hillington district of Glasgow for twenty years. In return for a loan, borrowers would hand over their benefit books. When the benefits were due, Law would give the borrower his or her benefit book back and collect his interest when they collected their money. The standard rate of interest was 25% per week, which works out at 11,000,000% a year! Needless to say, once you are in debt to a loan shark it’s virtually impossible to escape. Eventually Law was jailed for ten months for his actions, but you can bet that as he left there were ten more men to take his place.

The problem is that loan sharks exist because of Smith’s simple theory of supply and demand. There is a demand for money but no legitimate supply for the demographic most at risk. And that, according to the companies involved, is why mainstream lending is making its mark in traditionally loan shark territory.

In 2004 the Competition Commission started an investigation into doorstep lending, following a super complaint by the National Consumer Council. The concern was that doorstep lending worth an estimated £2 billion a year targets the UK’s poorest communities. It was the Commission’s task to consider whether lenders were exploiting vulnerability and low levels of financial literacy to generate excessive profits. Despite average interest rates of 177%, with some even in excess of 1000%, the Commission discovered that in the absence of any other viable option most borrowers didn’t care about the interest rates or cost of credit, only whether they could get hold of the money and afford the repayments.

The Commission found that, ‘Profits substantially in excess of the typical cost of capital have been persistently earned by firms that represent a substantial part of the market.’ However, they also discovered that most customers were satisfied with the services they received… hardly surprising, considering their options are extremely limited.

HERE’S AN IDEA FOR YOU…

Credit cards aren’t cheap! Do you know what rate of interest you are currently paying? Find all the documentation for your credit and store cards to discover exactly what Annual Percentage Rate (APR) you are paying. Cut up the card with the most extravagant interest rate and resolve to clear that debt first.