Why are interest rates different for different kinds of loans?
Before I answer the question, let’s first understand how loans work.
So let’s say that you are short on money and need or want to pay for something. You then go to someone who is willing to give you money under the promise that you pay it back. However, due to inflation, the value of the money may erode over time. This could mean that even if you pay back the same amount of money you borrowed, it might now be worth much less. Also, the lender has to worry about you not paying the money back. And, the lender is giving away money they could have invested elsewhere.
How does one make sure they get all their money back?
This is where interest comes in. By paying a certain percentage of the amount of money loaned per certain amount of time (whether that be days, weeks, months, or years) that lender is giving him or herself a little bit of cushion if the case should arise that the lender shows their self untrustworthy, or some other issue; as well as earning a little income…which actually may end up being a lot depending on how much was borrowed. The less amount of money you borrow probably will mean a less amount of interest.
The amount of time you have to pay off a loan also affects the amount of interest. The more time they give you to pay off a loan, the more you have to pay in interest.
It is interesting (and perhaps important) to realize that interest rates are different for different lengths of time. This could affect the payback time and, therefore, could mean that either more or less is at stake for the lender.
Here are some rates for loans
Brian O’Connell had the following points,
- The amount of interest paid depends on the terms of the loan, worked out between the lender and the borrower.
- Interest represents the price you pay for taking out a loan – you still have to pay off the base principal of the loan, too.
- Interest on loans is usually pegged to current banking interest rates.
- Your interest rate on a credit card, auto loan or another form of interest can also depend largely on your credit score.
- In certain cases, like with credit cards, your interest rate can rise if you’re late on a payment, or don’t make a payment.
Colton Beckwith phrases it well,
“The longer they give you to pay off the loan, the more interest they charge. Interest is charged by a percentage of the amount of money loaned…Different kinds of loans are paid off over various lengths of time, causing them to have varying interest rates. Generally, the smaller the loan, the less time they give you to pay it off, meaning a lower interest rate.”