Why interest rates are different for different kinds of loans

A lot of people are confused about why loans such as credit card loans have a much greater interest % than loans like mortgages. A lot of people are confused about why differently termed loans have different interest rates.  A lot of people are confused about why interest should even exist. There are several good reasons for this. First, there is the fact that the lender cannot do anything with his/her money while somebody else has it. Money can be used to buy necessary things or be put in a savings account, and make itself useful. So interest can be thought of the fee for “renting” the money.  Second, there is the risk that the lender will not get his/her money back. The lender can have a thing called “collateral.” This is simply something that the lender can claim if the borrower does not pay the money back. For instance, for a car loan, the car itself can be claimed by the car company in the instance of the buyer not paying the money. This is why credit and student loans are so expensive. There is no collateral. The only way for the lender to get the money back is by sueing the borrower, and that is not cheap or enjoyable. The third and final thing is called “inflation risk.” This just means that the money paid back by the borrower could have less value at the time of repayment that at the time of lending. These three reasons can also help explain why interest rates are different for different periods of time. For the time value, it takes longer for the lender to get his/her money back, and therefore less possibilities to use that money productively. For the default risk, the borrower has more time to stall on payment of the loan, and therefore there is more need to reclaim collateral or file a lawsuit. For the inflation risk, the money has had more time to degenerate in value. Here are some typical rates: For a 15 year fixed mortgage, the APR is approximately 3%. For a 30 year fixed mortgage, the APR is approximately 3.5-4%. For a 5 year car loan, it varies by the type of car but goes from 2-10%. For a buisness credit card, the APR can go fom 10-30%! So I hope I have proved my point, and that you now understand why different loans have different rates.

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