Everyone knows what interest rates are, right? It is the amount, usually a percentage but sometimes a flat fee, that you pay to borrow money. It costs money to borrow money, and interest rate is that cost!
There are different interest rates for every type of borrowing: mortgage rates are different than car loan rates, which are different from personal loan rates, which are different from payday loan rates.
You get the idea.
There are a lot of different branches of the industry, and each has their own industry standard interest rate.
But have you ever thought about what determines these rates? Why are the industry standards the industry standards? Where do the numbers come from?
It all has to do with risk.
Risk and Interest
The guiding principle in lending is risk. If there is a 0% risk of someone defaulting a loan, theoretically speaking, the lender could afford to charge a very very low rate. But this is not reality, in reality there is always risk involved. The lender is taking a chance that they will never get this money back.
The lower the risk, the lower the interest rates.
Mortgages are a great example. A mortgage loan is back by the property and house involved, so if for some reason the loan isn’t repaid, the bank gets the house. They have a very low risk of losing, so a mortgage is often for a much lower rate, over a longer period of time, for a larger amount.
Compare that with a payday loan. This kind of loan is small dollar and short term, and yet has among the highest interest rates of any loan on the market.
It’s due to risk. There is a very high chance of default, so the lender has to charge substantially higher rates than other kinds of loans.
Lenders have to take a risk with loans, but that doesn’t mean you have to. If you ever find yourself in need of a loan, consider the safe, secure installment loans of National Small Loan.