You may have wondered, “Why are there interest rates for different types of loans? Why are is there even such a thing as more than one kind of loan?” Well, I’m here to tell you what I’ve learned about loans and interest rates.
First, about different types of loans. There are many different types of loans; home loans, car loans, student loans, and credit card loans are some examples. The difference, between, lets say, a car loan and a credit card loan, is that, in a car loan, there is a car for the bank for own if the loan isn’t payed. So, if you can’t pay your loan on the car, not only does your credit plummet, but the bank has a car in its garage to be sold, to compensate it for its losses. However, the opposite is true in a credit card loan. The credit card has nothing it can get back from the loan, and so its risks are much higher. Thus, higher interest rates, as I will get to in a moment.
Now, about interest rates. Remember the example between a car loan and a credit card loan? Its about 3% for a car loan and 15% for a credit card loan at the time of the writing. Why? Remember the greater risk in a credit card loan? The way that credit card companies compensate for their losses is by having high interest rates, a sort of insurance without insurance. The reason why there are still interest rates for a car loan is because there isn’t a definite chance that the car will be sold. Note: Due to the Federal Reserve and other government intervention, interest rates are currently lower than they would be under these circumstances.
But what about the difference in interest rates for different lengths of loans? Well, consider this. What if the borrower lost his job about 15 years into a house loan. This most likely means that it is impossible for him to pay off his debt, and so the bank gets the house. Now, this risk is unknown, and the possibility of him being fired is not completely known to the bank. So, the interest rate. Depending on the length of the loan, more and more interest, or profit, is being payed in the first few years than in the final years of the loan. The shorter the loan, the less chance of something happening to the borrower, and the more principal payed in the early years over interest.
So that is your little talk about the difference between different types of loans; loans that are for a specific item that can refund the lender if the borrower is unable to pay off the debt, and the total opposite; the lender is dependent almost completely on the borrowers word and credit score. These types of loans are much riskier, and thus, the higher interest rates.
Hope this helped somebody! Have a good day!