What is a Loan Shark?
Loan shark refers to the person who lends the short term loan generally informally, illegally and in an unregulated manner to the borrower, for which high rate of interest is charged and in case the borrower makes any default in repaying the loan amount or interest on time then there is physical danger to him from the loan shark.
Some loan shark charges rates can be as high as 1.5% per day. Along with the interest rates charged by them, they also charge additional fees at their whims and fancies.
- The activity of a loan shark is usually illegal, though it is portrayed as legal and the paperwork that the borrowers are made to sign appears to be legitimate, though it has no legal enforceability.
- The interest rates on the loans offered to, depend on the number of loans and it is generally inversely proportional to the amount borrowed. For loans that are smaller in size, this tends to charge higher interest rates as compared to higher-value loans.
- The primary reason for such discriminatory pricing is the cost of “sharking” which remains the same regardless of the loan amount.
- The target clientele for loan sharks used to individuals who had a steady and respectable job and thus, a reputation to protect. They avoid targeting individuals who are self-employed or are already disreputable.
- This concept emerged in the US, more in the 19th century, when interest rates were low and small loans were not profitable. Thus, banks and other legitimate lenders stayed away from short term lending. At that time, these seemingly legitimate lenders operated out of proper offices, borrowed money from the legitimate lenders at reasonably low prices and lent at illegally high rates to the people in need.
Recovery Mechanisms of Loan Sharks
Since the loan agreements entered into by the loan sharks are not legally enforceable, they have no legal right to recover their money legitimately. It usually resorts to practices such as
- Threatening to cause disrepute
- Complaining to defaulter’s employer
- Sending agents to stand outside defaulter’s home and loudly denouncing them
- Vandalizing home with graffiti or notices
These sharks help individuals who are in need of money, when they fail to get finance from banks or other legal sources, by providing them money at the time of requirement. Following are the advantages of loan sharks:
- No or Low Documentation – Loan sharks either require no documents before financing or the documents required by them are minimal.
- No Requirement of Credit Rating – Loan sharks don’t require credit ratings of the borrowers before funding them.
- No Security Required – As discussed above, Loan sharks funds on the basis of reputable job and other aspects and doesn’t require any security.
This offer money to individuals easily without much of hassle and documentation but that comes with certain disadvantages, some of which are explained below:
- Exorbitantly High-Interest Rates – Interest rates charged by loan sharks are exorbitantly higher than the interest rates charged by banks of other legitimate providers of funds. Generally, the interest rates charged by loan sharks are mentioned on a weekly basis instead of annual. For example, A lent $ 1000 to B and B agreed to pay a 5% weekly interest rate on the amount borrowed. 5% each week would mean 20% each month and for a year, this would amount to 260% interest.
- Terms are Confusing – The terms and conditions of the agreement made by loan sharks are often confusing. This includes repayment terms, interest rates, etc. The weekly interest rate which is mentioned on the agreement may not seem high but these may translate into an interest rate which is 10 to 20 times higher than interest as per traditional, legitimate loan agreement.
- Loans are Hard to Pay Off – The loan agreements and conditions are designed in a way that makes it almost impossible for the borrower to repay the loan. Since the interest rates charged by the loan sharks are exorbitantly high, all that borrower ends up paying is towards the interest and the principal amount is difficult to repay.
Loan Sharks vs Payday Lenders
Loan sharks are the illegal and non-legitimate lenders who lend without a credit assessment and without paying much importance to the eligibility of the borrower, whereas Payday lenders, on the other hand, are legitimate lenders, who offer funds at high-interest rates to the borrowers. They do follow a credit application process and funds after performing the credit check and assessing the eligibility based on the borrower’s income and credit profile.
The maximum rate of interest that payday lenders are allowed to charge goes up to 400% per annum, as against the normal lending rate of up to approximately 45%.
This has been a guide to what is a Loan Shark and its Definition. Here we discuss the reasons why loan sharks charge high interest, their recovery mechanisms, advantages & disadvantages. You can learn more about Corporate Finance from the following articles –