Why do interest rates on consumer loans vary from one institution to another? Aside from reasons related to legislative permissions that allow different institutions to charge different rates for small loans, there are other considerations. Management fees tend to vary widely between lending institutions. For a small lending business, for example, administration fees tend to be quite high. This is because many of their loans are small in dollar terms. And it costs just as much to administer a $200 or $300 loan as it does to administer a $2,000 or $3,000 loan. In addition, small loan companies also make loans to people who have poorer credit risks. Because of this higher risk, they charge higher interest rates. Management costs of credit unions are very low. Because they are mutual organizations, they have very little overhead; often their employers give them rent-free office space. Their loss history is very low and they are given a tax advantage over commercial banks.
The insurance company bears no risk of loss by making a policy loan, and its cost of collection is very low because these loans are lump-sum loans that, in many cases, are never repaid.
Commercial banks, generally speaking, lend only to the best credit risks. Due to this circumstance, its history of losses is very low, a fact that reflects its interest collection. Savings and loan associations also accept only the best risks. Therefore, their rates are often below those of finance companies and are comparable to those of commercial banks.
Industrial banks, on the other hand, accept more risk and charge higher rates than commercial banks. Furthermore, industrial banks make extremely small loans, from $50 to $100 and even less, resulting in a high administrative cost per dollar borrowed.
As a general rule, when borrowing money, you should first try your commercial bank, your credit union or, if you wish, your insurance company. They generally charge less than other lending institutions. You should also know that the maximum interest rate allowed on small loans (consumer loans) is higher than the rate allowed by general usury laws. There are basically three reasons for this difference in interest rates:
1. The cost of credit research is generally higher per dollar borrowed. It takes as much time to run a credit check and determine the credit worthiness of a person borrowing $100 or $1,000 as it does for a person borrowing $10,000 or $20,000.
2. Bookkeeping and record keeping costs are higher on a small loan than on a larger loan, per dollar borrowed.
3. There is often more risk for the lender due to the credit ratings of many of the people who borrow from small loan companies. Because of the higher risk of default, the lender insists on a higher interest rate as compensation for taking on the higher risk.
However, this third point, the high risk, is not always present, so if your credit rating is good, it is ridiculous to pay more than 12 percent on consumer credit. Certain lending institutions, such as commercial banks, will lend only to those with strong credit ratings, thus taking on a relatively small amount of risk. Personal finance companies will lend to those with poor credit ratings; they take more risks and charge higher interest rates. While most interest charges, even those as high as 30 or 40 percent, are perfectly legal, there are some lenders who break the law and are illegal “loan sharks.”
Small loan laws are intended to protect both the borrower and the lender. The lender is allowed to charge higher rates to compensate you for credit research, bookkeeping, and risks. The borrower receives some protection because, while he pays what may be a relatively high rate in some cases, there is a cap on the rate he must pay. can be charged. Were it not for the legal cap, he could fall into the hands of an unscrupulous lender who could charge him even more. The unsuspecting consumer should be aware that when money has been slowed down to a usurious rate, most states provide for the forfeiture of principal or interest or both.