Last time, I talked about equipment financing rates, and why banks may sometimes have a lower rate than other lenders due to the fact that the bank lessens their risk by demanding collateral and tying up accounts. So let’s stay on the rate topic and look at other types of lending, and why rates are what they are.
As I stated previously, almost all lending rates start out the same, and then are adjusted for risk. This is true with “the big three” of loans that many people get – credit cards, auto loans, and mortgage loans. And they all have different risks to lenders (with credit cards being the riskiest, to homes being the least risky). Let’s look at all three:
Credit Cards – Easily the biggest lending risk out there. This is because they are usually given out unsecured by any collateral. And add to that the things people buy with them have almost no resale value (TV’s, Blu-ray Players, dinner at the Golden Goose, etc.) So the credit card issuer is taking on a ton of risk, which means rates are really high (18-25% typically).
Cars and other vehicles – These are squarely in the middle of the “risk” table. To begin, there is often a down payment required, so the borrower has something in the deal. In addition, in most cases, the vehicle has a fairly robust resale value. Yes, it’s not going to recoup things 100% for the lender (after all, the vehicle is worth less the minute you drive off the lot), but while the loan is active, the thought is the vehicle could be repossessed and sold. So while the lender isn’t happy when they have to repossess (and you are even less happy when the repo man shows up), at the minimum, they are going to get something back. So auto loan rates reflect this “lessened” risk.
Homes – Historically, real estate typically goes up in value. Ok, perhaps that bubble burst in the last recession, but that’s an anomaly – a home and property can almost always be resold. Add in a down payment, and you have a situation where the lender has a much smaller risk. This is why mortgage rates are the lowest of these three loan types.
The above doesn’t include a borrower’s credit score (which matters) and down payment size (which will also matter), but those tend to vary from loan to loan. But barring that, the risk assumed is what makes these three types of loans so different from each other in terms of rates. So that’s why you are paying 20%APR for that prime rib.