Different Types of Loans

I thought it would be useful to quickly go over some of the different loans out there from the lowest to highest interest rates (in general). While the order may be slightly different for some people the general order should be pretty similar for most. I’ll also explain why they fit where they fit in relation to each other in our current interest rate environment.

Car Loans

Car loans are secured credit. Secured credit is backed by an asset (in this case the car) and if you miss your payments the bank can (and will) repossess your car. For the most part these are some of the cheapest loans out there right now due to the current interest rate environment and the short period of the loans (3-5 years). The bank doesn’t have as much risk that interest rates will rise in this short time period as they do with a longer term loan such as a mortgage.

Mortgages

Mortgages are also secured credit. If you quit making payments on your mortgage the bank can foreclose and take back the asset (your house) that secures the loan. Besides the best mortgage rates, the reason interest rates are higher on mortgages (right now) is because mortgages are normally for a longer time period and there is more risk that the interest rate will increase before you pay the loan off which would be bad for the bank.

Home Equity Line of Credit

These are also secured loans but there is one main difference that normally makes their interest rates higher than the primary mortgage on a home. With a home equity line of credit the bank who loaned you money has the secondary right to the property after the primary mortgage holder. If the house goes down in value and the first bank with the mortgage can not sell it for more than what it owes the bank that gave you your home equity line of credit will get nothing. This is a much bigger risk for the bank and they normally charge a premium for that risk.

Unsecured Debt

There are many different types of unsecured debt including private loans, credit cards,  cash loans (also called payday loans) and many others. These are normally the most expensive form of debt and I listed them in the normal order of interest rates from lowest to highest. Private loans are normally the lowest but are probably the hardest to get. Credit cards can vary greatly depending on the card but are generally anywhere from 4.9% (if you were lucky to get a fixed rate CC forever ago) to as high as 29.99% and higher! Cash loans (payday loans) are even higher than that and can be anywhere from 100% to over 1000% interest a year. Crazy huh?

So why is unsecured debt so much more expensive than secured debt? The reason is because if you don’t pay they don’t have anything they can take away from you to sell to get their money back. They are relying on your promise to pay the money back. Of course they could always take you to court and garnish your wages but that gets expensive fast.

Not everyone pays their loans back so these lenders have to charge much higher rates of interest to make sure that they’ll make a profit even if some of their loans default.

It is always best to get the lowest interest rate possible if you must go into debt but make sure you know what you’re getting yourself into.