# When Costly Small Loans are the Best Option

##### Jul 31, 2019

This is a case study about why sometimes a costly small loan may be the only way out for certain people, adapted from the report of Trends in the Australian Small Loan Market by the Australian Centre for Financial Studies. I add some discussions and further questions in the end.

## Case Study

### Background

Alice is a single mom with children who relies only on Centrelink payments. Her refrigerator suddenly broke and she needs a new one as soon as possible before the frozen food for the family perishes.

### The Best Decision

Alice eventually decides to take out a small loan from a FinTech loan provider that can approve the loan and fund it immediately. At first, it is very tempting to take the lease option as it costs only \\$28 per fortnight. However, the lease lasts only 4 years and there’s no guarantee that she can keep the fridge afterwards at no extra costs. Taking a small loan is probably the only way out.

## Discussion

I simplified this case study a lot, but we still can see that for an individual who faces considerably limited options and urgent liquidity needs, a costly small loan may be the best choice.

However, as readers can calculate yourself, the effective “interest rate” or cost on the small loan is really really high. In 2017, regulations changed and now lenders are not allowed to charge interest on the loan. Instead, they can only charge:

• a one-off establishment fee of 20% (maximum) of the amount loaned
• a monthly account keeping fee of 4% (maximum) of the amount loaned
• a government fee or charge
• default fees or charges (maximum 200% of the amount loaned)
• enforcement expenses (the costs of the credit provider going to court to recover the money)

Still, putting the establishment fee (20%) and account keeping fee (48% p.a.) together is already overwhelming, let alone the default fees, etc.

## Further Question

The high cost of small loans receives tons of criticism even after the new regulation in 2017. However, is a cap on the costs of small loans indeed a good thing?

This is more than an economic question. I don’t want to discuss a lot about it but one question is that if a small loan with this high cost is still the best option for certain people, where’s wrong? The government, the people, the lenders or someone else? If a cap on loan costs drives some loan providers out of the business, who’s hurt the most? The people in need or the evil lenders?