Comments on: Why are there so many different Interest Rates?

By: admin

admin — Thu, 06 Dec 2007 14:09:00 +0000

Tim, thanks for the comments. I think it makes the comments better than the post.

By: Tim

Tim — Thu, 06 Dec 2007 13:35:49 +0000

Because different types of loans, different types of borrowers and different economic conditions result in a wide array of combinations of risk, maturity, inflation expectations and liquidity.

Treasuries tend to have low rates of risk and have low liquidity premiums (at least in the U.K and U.S). Differences largely are due to inflation expectations and maturity.

Home loans have a variety of risk (depending on borrower), and maturity. Inflation expectations vary, and liquidity risk tends to be high because it’s hard to convert homes (and mortgages) to cash on short notice.

Credit cards have high risk (again depending in part on the borrower), variable maturity, and tend to have high liquidity risk. (It’s hard to convert these loans to cash when in many times the financed item is already consumed, leaving nothing to repossess.)

These are just examples.

By: CD Rates Blog

CD Rates Blog — Tue, 04 Dec 2007 16:09:19 +0000

And kindly most instutions report rates in the APR and APY so that you can compare apples to apples across products. If a mortgage loan is offering a teaser rate of 2% for the 1st year, but 6.5% APY you can now compare that with a no point loan at 6.25% APY. Over the life of the loan, the 6.25% will be a better deal.

ChrisCD
Jumbo CD Investments, Inc.

By: Tim

Tim — Tue, 04 Dec 2007 13:08:47 +0000

Another way to consider this is to look at the components of a rate. Each rate is made up of components, and as these components vary, the rate varies.

There is a basic return, which represents lost opportunity cost of the funds. There is a maturity premium – the longer the loan, the higher the rate generally. There is a risk premium – the rate varies directly with the likelihood of default, which depends in part on what the loan is used for. There is an inflation premium – the rate rises with the likelihood of price increases during the life of the loan to offset losses in purchasing power. And there is a liquidity or market premium – the rate rises if it is more difficult to resell or transfer the loan to another party.

There may be more, but I’ve found that much of a rate can be explained by these factors.