Why do interest rates on consumer loans vary from one institution to another? Aside from reasons involving legislative permissions enabling the various institutions to charge different rates for small loans, there are other considerations. Management expenses tend to vary greatly among the lending institutions. For a small loan company, for example, management expenses tend to be fairly high. This is because many of their loans are small dollar-wise. And it costs just as much to manage a $200 or $300 loan as it does for a $2,000 or $3,000 loan. In addition, small loan companies also make loans to people who are poorer credit risks. Because of this greater risk, they charge higher interest rates. The management costs of the credit unions are very low. Because they are mutual organizations, they have very little overhead; often they are given rent-free office space by their employers. Their record of losses is very low, and they are given a tax advantage over the commercial edges.
The insurance company suffers no risk of loss when making a policy loan, and its cost of collection is very low because these loans are single-payment loans which, in many instances, are never repaid.
Commercial edges, generally speaking, make loans only to the better credit risks. Because of this circumstance their loss record is very low, a fact which their interest charges mirror. Savings and Loan Associations also accept only the better risks. Hence their rates are usually below those of finance companies, and are comparable to those of commercial edges.
Industrial edges, however, accept more risk and charge higher rates than commercial edges. Also, industrial edges make more extremely small loans-$50 to $100 and already less-which consequence in high administrative cost per dollar loaned.
As a general rule when borrowing money, you should first try your commercial bank, your credit union, or, if you like, your insurance company. Usually they charge less than other lending institutions. You should also know that the maximum interest rate permitted on small loans (consumer loans) is higher than the rate permitted under the general usury laws. There are basically three reasons for this difference in interest rates:
1. Usually the cost of the credit investigation is higher per dollar lent. It takes just as much time to run a credit check, and determine the credit worthiness, on a person borrowing $100 or $1,000 as it does on a person borrowing $10,000 or $20,000.
2. The bookkeeping and record keeping costs are higher on a small loan than on a larger loan, per dollar loaned.
3. There is often more risk to the lender because of the credit rating of many of the people borrowing from small loan companies. Because of the higher risk of default, the lender insists upon a higher rate of interest as compensation for assuming the greater risk.
This third point, high risk, is not always present, however, which is why, if your credit rating is good, it is ridiculous to pay more than 12 percent on consumer credit. Certain lending institutions such as commercial edges will lend only to those with substantial credit ratings, so they are taking a comparatively small amount of risk. Personal finance companies will lend to those with poor credit ratings; they take more risk and charge higher rates of interest. While most interest charges, already those going up as high as 30 or 40 percent, are perfectly legal, there are a few lenders who break the law rhey are the illegal “loan sharks.”
Small loan laws attempt to protect both the borrower and the lender. The lender is permitted to charge higher rates to compensate him for the credit investigation, bookkeeping, and risks The borrower receives some protection in that while he pays what may be a comparatively high rate in some situations, there is a ceiling on the rate which he may be charged. If it were not for the legal ceiling, he might fall into the hands of an unscrupulous lender who might charge him already more. The unwary consumer should observe that where money has been lent at a usurious rate, most states provide for the forfeiture of the principal or interest or both.