Borrowing Costs

Why is the interest rate higher on personal loans than mortgages and car loans?

The main reason why the nominal interest rate is higher for personal loans and payday loans than mortgage loans or car loans is that unsecured loans constitute a higher risk for the bank than other loans. With a mortgage, the bank will have first priority to take over the house if borrower fails to repay the loan. In the case of unsecured debt, the bank will not have any priority over other banks if the borrower fails to repay his loans. Consequently unsecured loans have more risk for the bank and thus higher interest rates than mortgages. Higher risk is one factor which affects the effective interest rate.

Another factor is the simple fact that personal loans are smaller than other loans, and therefore fees will contribute a higher portion of the loans and increase the effective interest rate. For example let us assume that a bank charge $100 to establish a loan. If your total loan is $10,000, the fee is 1 %. If you borrow $100,000, the fee will only be 0.1 % of the loan.

On the other hand, personal loans often lower interest rates than credit card debt, and therefore you can save money by using a personal loan to pay back expensive credit card debt.