Friday, July 8, 2011

The Thin Line Between "Fees" and "Interest"

A couple of days ago, I posted about consequences of restricting payday lending, and how it serves as a modern example of the impulse that once produced usury laws. Payday loans charge a "fee," rather than "interest." But historically speaking, actual term for "interest" on a loan grew out of fees. Joseph Persky explained this point in an article in my own Journal of Economic Perspectives a few years ago: "Retrospectives: From Usury to Interest."

Joe wrote: "Canon law in the Middle Ages forbade usury, which was generally interpreted as a loan repayment exceeding the principal amount. Our modern word “interest” derives from the Medieval Latin interesse. The Oxford English Dictionary explains that interesse originally meant a penalty for the default on or late payment of an otherwise legitimate, nonusurious loan. As more sophisticated commercial and financial practices spread through Europe, fictitious late payments became an accepted if disingenuous way of circumventing usury laws. Over time, “interest” became the generic term for all legitimate and accepted payments on loans."

One of the big trends in modern banking and finance it seems to me, is a move toward making a greater share of revenues based on fees. Whether it is fees for bank overdrafts, making a late payment on a bill, going over your credit card limit, the example of payday loans in my earlier post, or in a number of other ways, many of us tend to accept as reasonable a level of "fees" that we would find intolerable if they were phrased in terms of an annual rate of interest being charged.