Have you ever shopped for a personal loan online only to discover that rates and fees among lenders can vary considerably? The same is true in the mortgage market, automotive lending, and even hard money. Each lender sets its own rates and terms within the framework of what state and federal regulations allow.
Regulations do allow some measure of freedom in order to encourage lenders to compete. Still, that does not explain all the variation. It also doesn’t explain why some lenders charge certain fees and others do not. What we do know for sure are the reasons behind interest and fees.
Why They Are Assessed
It is virtually impossible to get a loan without any interest or fees attached to it. Lending is a business. Borrowing is nothing more than a service provided by the lender. Consumers must pay for that service. More specifically, there are three reasons lender’s assess interest and fees:
- Making a Profit – Lenders do not make loans because they have nothing better to do. They do not lend out of the kindness of their hearts. Lenders make loans to make money. They want to turn a profit on the service they offer. The only way to do that is to charge for the privilege of borrowing. That is what interest and fees amount to.
- Covering Their Costs – In addition to making a profit, lenders need to cover their costs. For example, a mortgage lender must pay for an appraisal to guarantee that the property being purchased has enough value to cover the loan. That cost is ultimately passed on to the buyer.
- Protecting Against Loss – Lending is risky business. Lenders need to protect themselves against financial loss, which is partially accomplished through interest rates. The more risk a borrower poses, the higher their rate.
Interest and fees may seem excessively high to consumers, and maybe they are, but lenders are just trying to run a profitable business. They are not any different to the local department store or auto repair shop.
How Rates and Fees Are Set
Banks and private lenders alike set their rates and fees according to their individual policies. Actium Partners, a Salt Lake City, UT hard money lender, says that most interest rates are rooted in the federal government’s base rate. Lenders start with the base rate and then add additional points on top to meet their respective financial goals. Retail rates are generally a point or two above the base rate.
As for the fees lenders charge, these are very much contingent on the cost of the services they cover. Let us say an appraiser charges $300 for his services. That is the minimum amount the bank would turn around and charge the customer. But the bank might also mark up the price so as to make a little bit of profit on the appraisal.
Lenders incur all sorts of costs that tend to vary based on the type of loan being considered. Mortgages incur far more costs than auto loans. Banks incur almost no costs when making personal loans. Yet they still charge fees. Why? To cover the actual labor they put into loan approval and underwriting.
The best way to wrap all of this up is to explain that interest and fees represent the only way lenders can cover their costs and make a profit. Through interest and fees, consumers are paying for the service lenders provide. The higher the loan amount, the greater the value of the service. The higher the risk, the more the borrower will pay for that service.