When you need to secure a loan or some type of financing, how much you are paying in interest makes a big difference for how much you are paying for the overall loan. The amount you pay in interest charges can be lessened greatly if you pay attention to the three important factors that affect how your interest rate is calculated by lenders. The smaller the interest rate, the more money you save over the life of the loan.
So what makes up your interest rate on a loan?
There are three main factors that influence how much you will pay in interest charges. They are:
The Federal Reserve Discount Interest Rate
In order for lenders to have the ability to lend you money, they must borrow the cash from the Federal Reserve Banks. The Federal Reserve charges an interest rate to the lending institutions for a short term lending situation. The discount interest rate is established by Federal Reserve’s Board of Directors. It is this discount interest rate that has a direct effect on how much the Prime Interest Rate will be for consumers. The Prime Interest Rate is the amount that borrowers will repay to the bank.
There is nothing a consumer can do about influencing this rate, however you can check out the current prime rate amount when shopping for a loan.
Consumer Credit Reports and Scores
The information being reported back from your creditors is collected by the three major credit reporting agencies, Equifax, Experian, and TransUnion. This information is compiled into a history profile that represents how well a consumer manages their debts, how long they have had credit, and what is the status of all active creditor accounts. The information is also used to calculate a credit score, a three digit number, that is reflective of your ability to handle credit and is used as a gauge by other lenders as to whether or not you are a credit risk. Lenders will use the score to ensure a consumer has the ability and the reputation for paying bills on time and using credit wisely.
Your FICO score and credit history reports are very much in your control. If you pay your bills on time, do not overextend your credit, and have verified your history reports as being accurate, you will earn a higher credit score. Those with high scores will get the best rates when financing a loan, a car, or a mortgage. Low scores mean you will pay more in interest and may find it more difficult to be approved by lenders.
Business Bottom Line
The last factor involved in interest rate calculations is the bottom line of each lending business. Lending is a competitive industry and banks and other lending institutions will have their own rules and standards for establishing lending terms and interest rates. Their goal is to avoid as much default risk as possible while making a profit.
Banks and other lenders do want to be competitive so interest rates will vary among them. It is in the consumer’s best interest to shop around at different lenders to find out where the best interest rates are.