Why Are Interest Rates On Short-term Loans Not Necessarily Comparable To Each Other? Give Three Possible Reasons.


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Beth Kennedy Profile
Beth Kennedy answered
Short term loans, sometimes referred to as a "payday loan", can have varying interest rates. There are many possible reasons for this but three of the main ones are outlined below:

  • Applicant risk
  • Duration of the loan
  • Tax considerations
When short-term and long-term lenders offer potential customers a loan they will always take into account the risk of not being repaid. The bigger the chance that the applicant can't repay the loan, the higher the interest rates will be. The lender will offer the loan with a lower interest rate if the applicant has a lower risk of not repaying the loan. This is why governments borrow money at lower rates than private companies or individuals. Individuals and private companies can attempt to lower interest rates by offering collateral. This is property that the lender can keep if the borrower fails to repay the loan. When applying for any sort of loan you will have to declare your income and possibly pass a credit check to asses your credibility. These factors are considered when determining interest rates on short-term loans.

The duration of the loan is an important aspect of determining the interest rate of the loan. The longer the borrower wishes to have the loan, the more likely the lender is to give them the loan. This is because the lender will earn a lot more through interest if the loan is offered for a longer period of time. Inflation also plays an important part in the level of interest rates. The longer duration a loan is given, the higher chance it will be hit by accelerated inflation. This means short-term loans usually have a lower interest rate.

After-tax income is a factor that lenders consider when determining the interest rates of a short-term loan. This is the interest the lender gets minus any taxes they may have to pay on that interest.

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