Why does it cost so much to borrow money?
Posted on: 29 October 2015
Lenders charge borrowers to borrow money because they, like all businesses, need to make money to survive. At the same time, lenders also use fees to pay for the costs of running their business. Lenders can be banks, but can also be pawnshops, payday, or title lenders.
But how does a lender determine how much they will charge their borrowers? This post looks at the four major costs that a lender uses to determine the rate they will charge:
- Customers who don’t pay back loans: Lenders know that “life happens.” Even if all the borrowers want to pay back their loans, not every borrower will be able to. Good people lose their jobs, get sick or worse. Lenders plan for this by charging a higher rate. The little bit extra that each customer pays covers that bank for the rare case when a customer is unable to repay their loan. At the extreme, when a lender has many borrowers who are unable to repay their loans, they must charge a much higher rate to all borrowers.
- Advertising: Your business is valuable and lenders compete to lend you money. You see their advertisements on billboards, in newspapers and on the TV. However, the lender needs to pay for these advertisements! To cover their advertising costs, lenders charge each borrower a little bit more for every advertising dollar they spend. Does this story sound familiar? That’s right, the more the lender pays for advertising, the more you’re paying as their customer.
- Staff: The people who read your application, check your references, and process your loan all need to be paid! Part of the rate that you pay for your loan is used to pay a lender’s employees.
- Rent + Utilities: Like you do for your home, lenders need to pay rent and utilities for their stores. You guessed it! Part of the rate you pay is also used to keep the lender’s store running.
After subtracting the four major costs above, that’s the profit that a lender makes. To put this in perspective, many of the big banks don’t make very much money after these four costs are accounted for. However, there are greedy lenders out there who will try to take advantage of you and charge you more, and we’ll cover how to spot these imposters in a later post.
Hopefully the next time you are at a lender, you’ll think of this post and it will help you understand a little bit better how the lender decided on its rates.
As always, if you have any questions about this post or just question in general please email us at firstname.lastname@example.org. We’re here to help answer your questions!