Secured with cash vs. secured with a depreciating asset??

S

sweetbriargirl_IHB

New member
Finance is not my thing, and this just doesn't make sense to me. Can someone explain?



I would still be driving my 13 year old Acura if it hadn't been stolen when I was living in Texas. So now I have a car loan with an $11k balance at a Texas credit union, at 6.50%. I live in California now and thought, hey how about if I get a loan from the credit union here and pay it off so I can close that Texas account. I thought if I put the $11k in a CD and used it as collateral for the loan I'd get a really good interest rate since there's no risk to the CU. They've already got the money if I were to default. Isn't risk what interest rates are supposed to be based on? (Yes, I could just pay it off but I'd rather not. Long story.)



So I call. If I do a secured personal loan in which they hold my $11k as collateral in their hot little hands, the rate is 8.5%. If I use the now two-year old car, a depreciating asset, as collateral, one that they would have to pay someone to come take away from me if I defaulted, the rate is only 6.25%. I don't get it. Shouldn't I get a good interest rate if I secure the loan with actual cash as opposed to a depreciating asset that they'd have to go hunt down to repossess?



So many of you are so smart about this stuff. Maybe one of you can explain it to me? Thanks.
 
<p>Somebody sometime made a RULE about it for a reason which was logical at the time.</p>

<p>No bank or credit union ever changes a rule, because they don't understand what they are doing, the person who made the original rule is long gone, andthe employees feel if they change a RULE, and something goes wrong they will be blamed. Since no bank or credit union pays an adequate salary, nobody stays around long enough to understand what they do and why, and so the rules never get changed.</p>

<p>Since mistakes and creativity are absolutely not allowed, nothing is changed until the whole thing goes busto. Gosh--this is a lot like--socialism.</p>
 
I always like the way you think, Liz. I wish more of the lawyers where I practiced were like you. If they had been, I might have stuck it out instead of escaping into the more mundane world of academia.
 
if you use your cash as collateral, placed in a CD with the bank, you should think of the rate they give you as the roughly the diff between the rate on the debt minus the rate on your CD, no? you're paying them 8.5 but they're also paying you 4.5. thats the way the bank thinks of it, which is they miss the part that you could just keep the cash in a CD and earn interest in either scenario, but the bank can only think of the deal in terms of what involves them. makes no sense, you're right...
 
Its probably because the default rate on their auto loan product is lower than that of the secured personal loan. Any default implies costs and that doesn't change with the collateral. To use a simple example.





Cost of recovering money from any default, $1500 in lawyer fees (thats only 3-4 hours of legal advice) etc







<col width="136" style="width: 102pt;"></col> <col width="107" style="width: 80pt;"></col> <col width="88" style="width: 66pt;"></col>







Personal Loan

Car loan





Loan Exposure

11,000

11,000





Recovery on collateral

100%

80%





Collateral Recovery

11000

8800





Cost of recovery

1500

1500





Total recoveries

9500

7300





Total Loss

1,500

3,700















Probability of default

10%

3%















Predicated Loss




150

111










As you can see, the predicted loss is greater in the personal loan because of the probability of default is so much higher. I'm not sure of these default numbers, but I just used them to illustrate the point.





So to sum up, the personal loan product has a higher probability of default leading to a higher interest rate. This is why home loans carry such a low interest rate, the PD is only about 1% or so.
 
that probably makes a lot of sense. i can imagine personal loans getting having a high probability of default. they are typically taken as a last resort. if you're a homeowner, you can (well... historically, you <em>could</em>) take out a HELOC. there's no reason the risk assessment of the OP's loan should be any different than a car loan but the problem is your local bank or CU is often working from a template.
 
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