Loan analogy by Martin Lewis. I can't find it.

Appliance_engineer

Hi, I have been trying to find an analogy that ML made some time ago about borrowing £10 or something off a friend and something about repaying it and buying him a drink as a thank you was an example of worse than payday loan interest.

I can't remember the full gist of it but it was something like, it's a massive interest rate, but seems reasonable. I think he was making the point some years back about how for such a small amount, it would equate to far worse than the excessive payday loan sharks that existed at one time, but that in that particular example, it was a reasonable amount given the circumstances.

I remember it being quite an interesting take on the cost of borrowing, and it sort of excused the massive interest rates that payday loan companies were charging at the time.

If anybody can point me to the quote, I'd be grateful.

Appliance_engineer

I think Chat GPT has worked it out for me!

If I borrow £10 from a friend, and pay it back, then buy him a drink costing £4 as interest. What is the interest rate?

To calculate the interest rate in this situation, you can use the following formula:

Interest Rate (%) = (Interest Amount / Principal Amount) * 100

In your case:

• Principal Amount (the amount you borrowed) = £10
• Interest Amount (the cost of the drink) = £4

Plug these values into the formula:

Interest Rate (%) = (£4 / £10) * 100 = (0.4) * 100 = 40%

So, the interest rate in this case is 40%. You borrowed £10 and paid back £4 as interest in the form of a drink, which represents 40% of the original amount borrowed.

Johnmcl7

I think the problem you're referring to is the use of APR for short term loans which makes them look a lot worse than they actually are because it's an annual percentage rate but over a very short term.  I think it was Martin Lewis who demonstrated that overdraft charges and similar for banks actually had far higher APRs and were for a similar purpose had incredibly high APRs but because they were shown as fees they didn't have this APR on them so didn't look as bad.

In your example, if you borrowed ten pounds and paid it back a week later and bought a £4 drink that works out at 2,086% APR.  

Appliance_engineer

Thank you. That was indeed the thing I was talking about.