oops, guess that poll question range was too wide, not specific enough

[netmouse]

For those who answered (some form of) Yes, a certain loan interest rate seems excessively high, the majority responded that "too high " starts between 5 and 25 %, and I'd like to see a breakdown on that. Please answer this question too!

[Poll #1343223]

Comments

[netmouse.livejournal.com]

*shrug* what do you mean by risky? I presume we would only be talking the highest risk acceptable to a lender. What's that? I don't know what risk brackets lending institutions tend to operate in, but I would define "risky" as something slightly less than "horrendously stupid" and "sure path to losing billions."

Seth? what did *you* mean by risky?

[dagibbs.livejournal.com]

I don't know how banks "name" levels of risk -- but I'm sure one of the basic measures is likelihood to not pay back.

Ok, let's assume "risky" means that 1 in 20 people will not pay back the loan. Let's also simplify this too 1 year, to make my math easier.

The bank needs to make a profit off this, too.

Inflation 8% -- interest rates can't be less than that, or the bank loses money.
5% loss, means the banks lends out to 20, 19 pay back, therefor the 19 must pay back at least the amount the bank lent out to the 20 -- that's just over 5% right there.

So, to not lose money -- we're starting with an interest rate of 13%.

Now, there is cost of doing business, and profit on top of that. (And cost of capital -- but that gets funny, since banks are (kind of) allowed to lend money they don't have, at least I think that's how they work.) I'd be suprised if that was under 5%, too.

So, 18% is starting to look pretty reasonable from that point of view.

I don't know enough financial math to figure out how a longer term will affect the math, nor how amortization, where some of the capital is also paid off along the way, would affect things.

[yarram.livejournal.com]

You forgot that the effect of the 5% loss is spread across the remaining 19 individuals - so, step two is (8% inflation + (5%/19)) = approx 5.26%.

[dagibbs.livejournal.com]

I didn't. When I said "just over 5%" that's what I meant. My calculator is showin .0526 as the value for that as I reply here. I rounded that down to "just over 5%".

[yarram.livejournal.com]

Ah, OK, I see now. I was using the wrong numbers to figure the additional rate to apply to the initial 8%. It isn't the (5%/19) I created - it's (total value of one loan/19), which means each of the 19 assumes about 5.25% of the 20th (defaulted) loan. Of course, this assumes all loans are of equal amounts, but from the simplifications inherent in your numbers, that can be treated as a given.

The fact that I screwed up the math I was using doesn't help, either... 5/19 = .26, and I meant to add that to the original 8%. Don't ask me how the leading 8 of "8.26%" turned into a 5. Probably a typo - brain saw '8', finger typed '5'.

[sethb.livejournal.com]

It should really be 1/19 of the total at the end (so calculate the interest without loss, inflation + cost of funds + costs&profit, then multiply by 20/19). But the answer give is close.

5% default per year is really high; banks usually won't lend to that sort of risk (or will charge a lot more than their usual rate).

[sethb.livejournal.com]

Pretty accurate.

The bank borrows money; that's the .03% they pay on your checking account, or 2.5% they pay on your CD. They can't just create money. (They sort of do: when a business borrows $1 million, that money goes into the business's account at the bank, so the bank's deposits increase by it. As the business uses (spends) it, it leaves the bank.)