Did you ever think about how banks make money? Their main source of income (other than charging us a myriad of different fees) is lending money and collecting interest on loans. Banks will only lend money when they feel that the loan will be repaid. Makes sense, right? You would do the same. The strongest guarantee of repayment is when a bank takes something of value from a borrower, which can be liquidated in case the loan is not paid back.
When a bank lends you money to buy real estate their collateral, the guarantee that you will pay them back is a legal document known as a lien. In simple terms that means that a bank publicly records the fact that, even though you are the legal owner of the property, they have a legal right to take it from you through court action until you pay them back all of the money you owe. That court action is called foreclosure.
Our law is based on the English concept of public recording. It allows for a lien to be publicly recorded and for a lender to be able to foreclose. In countries where the system of public recording is either non-existent or not well developed a lender’s risk is much higher, which would mean higher interest rates in that country.
Interest rates charged by various lenders are determined by the following factors:
– The cost of funds, which can be either the interest rate the bank is paying to borrow money from other investors or the interest rate the bank is paying its depositors;
– The level of risk that the bank sees in that particular loan, i.e. borrower’s credit, down payment amount, type of property, etc. In this article you can find out why some types of properties are considered riskier by banks than others.
– Supply and demand forces of the market which prevent banks from charging you as high a rate as they want.
Interest rates on loans secured by real estate, i.e. mortgage loans, are lower than rates on any other types of loans because real estate is the strongest collateral, which minimizes the lender’s risk.