Different Levels of Hurt for Different Types of Loans
No matter what you borrow, you'll have to pay. Borrow your brother's shoes, and you might pay with a fist to the stomach. Borrow money from a bank, and you'll have to pay interest.
The thing is, what you pay depends a lot on the type of loan you have. If you're like most folks, the biggest loan you'll ever take on will be your mortgage. It's likely to be in the six figures or higher and will take you 10, 15, or 30 years to repay. It will also probably carry a fairly low interest rate—maybe 5% or 6%. There's a couple reasons why it's so cheap:
- The bank gets the house if you don't pay up, so they can sell the property and get their money back.
- You have to give the bank a down payment before they even think about giving you a mortgage, so if they have to take your house, they already have some cash in hand in case the value of the house has dropped.
- The amount of money you're borrowing is quite large, so the bank makes quite a nice chunk of change from you—even with a lower interest rate.
If you walk away from the house, even with legal fees and all the other costs of foreclosing, a bank will usually manage to end up just slightly ahead.
If you get a car loan, you're probably going to be paying around 6% or so. It's an installment loan, meaning that the bank pays the entire amount to the dealership and then you pay fixed installments to the bank until you pay the debt off. Car loans cost a little more than houses because the value of that Porsche, rusty Toyota, clown car, or Bugatti will start to drop the minute you drive it off the lot. The bank still gets the car if you default on the loan, but the car will likely be less than they gave you to pay for it.
Want to Pay a Lot for a Loan? Have we Got a Deal for You!
Credit cards are pretty much the most expensive way to borrow money.
Why? Because if you skip town and don't pay your bill, the credit card companies can't really take anything away from you. Oh, they can send collection agencies and write nasty legal letters, but they usually can't take your house, car, or even your good guitar. There is no collateral on that loan. You end up with a ruined credit rating, but the credit card company pretty much absorbs the loss.
We're pretty sure the president of Visa or MasterCard won't be sobbing into a silk pillow if you don't pay. Credit card companies are multibillion-dollar businesses so they can afford to have a few people run screaming for the hills. Part of the reason they're so wealthy is that they charge such high interest rates: the amount you pay on your plastic more than makes up for the fact that Deadbeat Dave never footed the bill.
If you have something big to pay for—such as college—save credit cards as a last resort. Try to pay with a line of credit or other secured loan that gives you a better interest rate. Yes, you're taking the risk that the bank will grab whatever collateral you used. But you're also not throwing gobs of money away.