Why moneylenders are secretly evil geniuses

Nov 24, 2016 06.00PM |
 

by Ryan Ong

TWO hundred and forty per cent interest. That’s what was charged to a local business owner, who just managed to dodge the moneylender’s attempt to have him declared bankrupt.

Licensed moneylenders, who provide “short term loans” or “payday” loans, are not a plague unique to Singapore. They’re everywhere in the world, because sooner or later every criminal learns it’s easier to wear a tie, and use contracts instead of guns. And as for laws and regulations, our moneylenders are geniuses at finding loopholes.

The inherent problem with moneylending

Licensed moneylenders provide loans to people who don’t usually qualify. People with low income, who are unemployed, who can’t get cash from a bank, etc. I think moneylenders have a special gland in their nose, that lets them detect desperation like sharks smell blood. In exchange for the high risk they take, moneylenders charge phenomenal interest rates. At present, this is up to 4 per cent per month, or around 48 per cent per annum.

For the sake of comparison, the typical credit card interest rate is 24 per cent per annum. An unsecured personal loan has an interest rate between 6 to 9 per cent per annum.

There is an inherent flaw in this entire business model, which almost guarantees an unhappy ending for everyone involved: the only people who are insane enough to accept an interest rate that high, are people who have no other way to get money.

And people with no other way to get money tend to be neck deep in financial troubles. Now what happens if you take someone who is already desperately short on money, and impose an interest rate that would break even a person with a decent income?

The answer is default. The moneylenders’ clients are more likely to fail to pay, because they have high debt obligations and low (or no) income.

This in turns prompts moneylenders to demand higher interest rates, which in turn makes it even less likely that their clients can pay. The advantage here, of course, goes to the moneylender – they can slowly extract payment, year after year, for an indefinite length of time because the borrower can never pay them back (thus eventually recouping the cost, and more).

Despite this massive inherent problem, moneylending gets licensed. Because the alternative (loansharking) is theoretically worse. When the only argument in favour of your line of business is “at least you’re not a criminal”, you know you’ve hit rock bottom.

 

But moneylenders DO have a bizarre streak of evil genius

It’s not true that moneylenders don’t have a conscience. Most do, and they probably keep it in a small matchbox under their offerings to Satan. But you do have to credit them for cleverness. Some of the loopholes they’ve masterfully exploited over the years include:

  • Exploiting amortisation
  • Exploiting late fees
  • Exploiting administration fees
  • Bypassing advertising restrictions

1. Exploiting amortisation

This was the situation with the aforementioned court case. The business owner in that case knew that he was being charged 240 per cent interest (he inked the deal before the law was passed, which would have kept his maximum interest at 48 per cent). However, what he didn’t know was that the moneylender would play with the amortisation of the loan.

When you take out a loan, there are two parts to it: the principal (the original amount borrowed), and the interest (which is based on the principal). For example, on a $5,000 loan with 48 per cent interest, the principal portion is $5,000 and the interest portion is $2,400.

Now when you repay a loan, the repayment usually subtracts from both the interest, and the principal. If all the repayments go toward only the interest, you could (depending on the interest rate and the amount repaid) end up paying forever.

In the above example, if your total repayments are $2,400 per year, you could pay $24,000 over 10 years and still owe the $5,000, which would still be accruing interest every year.

This was what the moneylender in question tried to do: they claimed that they still hadn’t been paid off, despite the borrower paying many times the initial sum, because the repayments were going towards paying the interest only. By using tactics like this though, they can render even the transparency of interest rates useless. You may know the rate, but you may not know that you can never pay it down.

 

2. Exploiting late fees

This situation has been stopped now. But prior to the government’s intervention, moneylenders were notorious for hiding the real costs in their fees. There was, for example, a cleaner who received a $600 late fee charge for a $400 loan. The cleaner signed a contract; one agreeing to repay the full loan by the next day, or else there’d be a $600 charge.

Oh, and then they gave him a repayment plan of $200 a month over five months. So yes, he was pretty much misled and doomed to pay that $600 from the start. Also, the cleaner didn’t speak English very well.

Again, note the evil cunning: when they resorted to tactics like this, the moneylenders could even willingly offer low interest rates. The real cost would be hidden in the fees, not the interest.

 

3. Exploiting administration fees

Today, moneylenders have administration fees capped at 10 per cent of the loan amount. This is supposedly an acceptable amount, for “legitimate costs like securing a credit report.”  I suspect TODAY was trying to be sarcastic to moneylenders, by using that specific example. It costs $6.42 with GST to obtain your credit report from the Credit Bureau of Singapore (CBS).

Previously, moneylenders would have high administration fees, that the borrower would have to pay again if they were late. So they could charge a $100 processing fee for a $500 loan, and when the borrower was late they’d treat it as a new loan (hence another $100 processing fee). Late five times? Bonus $500 for them, not including late charges.

Again, all quite invisible because people tend to check interest rates and not fees.

 

4. Bypassing advertising restrictions

Moneylenders are not allowed to advertise via a number of channels. But even today, they manage to skirt those restrictions. The most easily evaded one seems to the restriction against online advertisements.

A moneylender can’t advertise its own services; but they can spam headlines like “X number of ways to afford a car in Singapore”. One of those ways could be to seek legal methods of financing, and you can contact them for more details. Sure, it’s an online ad – but they haven’t technically advertised moneylending services, have they?

Financial blogger Timothy Ho, from Dollars & Sense, has also spotted another loophole, in that it’s possible to advertise a site that compares money lending services, but doesn’t offer the moneylending service itself. While the moneylenders can’t advertise themselves, they can get other platforms to do it for them.

 

Moneylenders will always be around in some form

There will always be people desperate for cash, and there will always be moneylenders who find ways to skirt the rules. But regulating moneylenders probably isn’t the best way to control them. It might make more sense to regulate debt collection activities. That’s the part of this business that causes a public nuisance – and when it’s too hard to get the money back, moneylenders may consider some other form of investment.

 

Featured image by Natassya Siregar.

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