Interest rates and securities are the cost of borrowing money, without these concepts, people or banks would not be willing to lend or save their money with each other (Edelberg, 2012). Interest rates and securities vary from one bank to another, or are even determined by the type of loan that one is requesting. It is obvious that a bigger loan will attract much interest rates and securities. Also, different banks especially those that are not run by the government have variations in their interest rates. One bank could offer more attractive rates than the other, thus, people usually would weigh their options before deciding on where to get their loan. Also, each rate is made up of components which vary from one lender to another. There are two major premiums that differentiate interest rates, which are default-risk premium and the maturity premium. The default-risk premium measures on the chances that the borrower will likely not repay the loan on time or might be totally unable to repay the amount borrowed. Measuring on these factors, the component will be low or high liable to the creditworthiness of the borrower (Edelberg, 2012). Maturity premium on the other hand, measures interest rates in terms of the period taken to repay the loan. The longer the time to maturity, the higher the premium and vice versa. It also determines the rates offered on the securities of various maturities.
There are different types of loans, and each has a precise intended use. Factors such as the length of time and how interest rates are calculated are what help in the classification of different types of loans. Home loans, for instance, have several risks depending on the creditworthiness of the borrower and also, on the maturity period (Harper, 2012). This is because most lenders find it difficult to convert homes and debts to cash on short notice. Such a loan carries a high interest rate. Long-term loans also have a high possibility of not being paid as compared to short term loans. This is because long-term loans are more vulnerable to be affected by inflation, and therefore, the longer the time to repay the loan, the more interest the lender receives. In conclusion, it is clear that when a loan has many risks involved in it in terms of payment, it attracts high interest rates. However, those that there is some sort of security that the lender can acquire incase the loan is not paid back, the interest rates will be lower.
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References
Edelberg, W. (2012). Risk-based pricing of interest rates for consumer loans. Journal Of Monetary Economics, 53(8), 2283-2298. http://dx.doi.org/10.1016/j.jmoneco.2005.09.001
Harper, M. (2012). Microfinance Interest Rates and Client Returns. Journal Of Agrarian Change, 12(4), 564-574. http://dx.doi.org/10.1111/j.1471-0366.2012.00374.x
