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5 Factors that Determine Your Interest Rate

Whether you are applying for a car loan or a credit card, a home mortgage or a personal loan from a bank, the lending institution you charge will (eventually) charge you interest as their way of making a profit from loaning you money. How much interest you are charged is determined by many factors that fluctuate from day to day, that’s why you are given the option, when taking out a significant loan like a mortgage, of locking in your interest rate on a particular date before the loan is actually finalized after escrow. Knowing what factors are important in setting your interest rate are important in helping you to get ahead in the lending and borrowing game and avoid being taken advantage of by high or predatory interest rates.

1. Market Factors: The first and primary factor that determines any interest rate for a loan are the market factors that affect how much it costs a bank or lending institution to – theoretically – get the money to lend to you in the first place. Chiefly the money or permission to lend comes from the federal government which itself charges interest to the banks as it gives out the money. This rate, along with other various factors sets the base interest rate that any bank could give away money at and not make a dime of profit. Of course, you aren’t likely to get away with borrowing money at this rate (or less) for anything longer than a brief introductory period if at all.

2. Your Debt to Credit Ratio: how much credit you have versus how much of it is being currently used (as debt) is an important factor in deciding how much your interest rates will be. The higher the ratio, the less likely you are – according to statistics – to be able to pay back a loan, so the bank will offset that risk by increasing your credit rate, making it harder for you to repay the loan. Makes a lot of sense, doesn’t it? If you have credit cards your available credit to debt ratio will be determined by your total available credit – say you have 5 credit cards, each with a $1,000 limit on them, your total available credit is $5,000, and you have charged, across the five cards, a total of $1,000. That is a total of 20% of your available credit as debt – a somewhat high, but not dangerously so – number.

3. Your Prior Credit History: How you’ve treated creditors in the past is a significant factor in determining your credit rating. If you have been faithful in paying off prior obligations, your credit rating will be high. If you have defaulted on loans, declared bankruptcy or are regularly late with payments, you will have a low credit rating, telling any potential lender that you are a greater risk of default and your interest rate will be higher as a result.

4. Having No Collateral:No collateral loans such as personal loans and credit cards are going to have the highest interest rates of all because in theory, the lender has nothing to recover at all should you default on the loan for any reason. Car loans and house loans will have among the lowest interest rates available because they have collateral (the house or the car) attached to them that the lender can repossess if you do not repay the loan as agreed.

5. Other Credit Factors: If you have been through debt negotiations, bankruptcy or have many late payments on your credit record, all of these will significantly increase the interest rate that a loan is offered to you at. Again, this is due to the increased risk you present to a lender for default. Having to have your debt negotiated to be different than what you originally signed on for is bad for your credit rating, paying your lenders (or utilities) late is bad for your credit rating, and filing bankruptcy, having debts discharges is essentially the worst thing you can do to your credit rating. All of these things will come off of your credit report in due time, but while they are there, they are the harbingers of a high interest rate for any loan that a lender might consider giving you.