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Before we discuss
interest rates for various types of loans, let us understand the
types of loans involved and the kind of people who apply for the
loans. When we talk of secured loans, we are describing transactions
where the borrower promises to give property or other collateral
to the lender, in case the borrower fails to pay back the money
borrowed with interest. This is why the loan is a secured loan—the
lender can keep or sell the property or collateral in case of non-payment
of the loan.
Interest rates for secured loans are low, because
most people do not like taking loans where they risk losing their
property and because these loans are given to low-risk borrowers—people
who are employed, own property, and would not like to see it auctioned
off to pay their debts. Such people, so banks assume, tend to pay
their bills on time.
A home loan mortgage or a car lease program is
a secured loan—the purchaser of a home or a car takes a loan, using
the car or home purchased as collateral. If payments for the car
or home are delayed, the car or home can be repossessed by the lender.
Borrowers who opt for secured loans pay these loans off over five
to thirty years—the long time taken to pay off the loan is another
reason why the interest rates are lower on secured loans.
Unsecured loans are those loans where the borrower
does not pledge property or other collateral in case of non-payment
of the debt. Unsecured loans are usually personal loans, given to
pay off medical, college, or household bills, to buy household gadgets
or cars, or pay for vacations or family functions.
People who apply for an unsecured loan may not
own property or may just be starting their career. They pay the
unsecured loan off over one to five years. Interest rates for unsecured
loans are higher because these loans are given to people who do
not own property, may have been employed for two years or less,
or may have no credit history or very poor credit history, which
could involve bankruptcy, foreclosure, non-payment of taxes, or
worse. Banks are very reluctant to lend money to such borrowers,
who may or may not pay off the money borrowed with interest, hence
the high interest rates. Other reasons for the high interest rates
on unsecured loans could be their popularity—many people would prefer
to take a loan when they know they risk losing nothing--and the
short period of time taken to pay off the loan.
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