Sunday, 28 October 2012

Lender fees - at arms length or a transfer? Plus fee-or-no-fee?

I just want to make two points about the lender fee I've introduced recently in my discussion on understanding rates of interest.  First, the world is a diverse and unpredictable place.  There's nothing to stop a lender giving a loan at seemingly crazy rates (either very high seeming, or very now seeming).  The other way of coming at this is to say that, for any given rate of return, there's some possible market environment which make this rate of return understandable.  And even if it isn't understandable, human beings are free to agree whatever rates they want between them (absent any usury laws which may be in place, of course).  If a lender lends money because they don't need to charge for it, or because they're favourably disposed towards the borrower, then the transaction is more like a transfer and less like an arms length business contract.  

The second point I want to make is that you know nothing about how much of a fee, if any, is being charged if all you know about the loan is the rate of interest.  This seems like such a strange thing to say that I'll pause a while before explaining more.  I'm saying that if I told you that a man walked into a bar and asked for a one day lend of £100 and agreed a rate $r$ with a lender, then you the listener have no clear idea of how much of a fee the lender charged, if indeed he did charge anything at all.  I will explain this more in a later post.  Looking at a rate is often a great place to work out the fee charged by the lender, but as I will show, this can quite easily be thwarted by adverse economic conditions.