All Loans Are Not Created Equal
Have you ever wondered why credit card interest rates are so high? Or why mortgage rates feel like such a bargain right now? There are reasons behind these differences that primarily have to do with the risk the lender takes in loaning that money out.
The three main categories of loans are unsecured, secured and education loans.
These are loans that don’t have a tangible item the lender could take back if the loan was not repaid. The most common unsecured loans are credit cards and unspecified/personal bank loans. Since you’ve already read our article on Credit Cards, we know you aren’t carrying a credit card balance, so the interest rate doesn’t really matter, but it’s still good to know where the number comes from. Since there is no item, like a car or boat, the lender can repossess in order to recover their money, this is the riskiest type of loan for the lender, and therefore the interest rates will be highest for these types of loans.
Like an unsecured loan, there is no tangible item that can be taken back if you don’t repay an educational loan, The lender can’t make you unlearn all those exciting facts you learned in Anatomy & Physiology. However, lenders view education as increasing your earning potential, which makes you more likely to be able to repay the loan, and therefore less risky than an unsecured loan. The other big difference between education loans and other types of loans is the payment schedule. Education loans will accrue interest while you are in school, but are not expected to be paid back until you complete your education program, or until a specified date, whichever comes first.
Secured loans are considered the least risky for lenders because there is a physical item they can take back if you fail to repay the loan. The most common things that are considered secured loans are cars, boats, houses, or any other large items that would be specifically named on the loan. You can also leverage savings as the loan collateral, if you have a savings account that you don’t want to touch, but need money for something that would normally be considered an unsecured loan. The benefit in doing this is that you will be able to get a lower interest rate if you name the savings account as collateral.
What we have covered here is just a quick overview of the most common loan types and the basics of where interest rates come from. Keep your eyes peeled for our upcoming articles where we’ll get into all the juicy details.