An interest rate is the cost of borrowing money. Rates are expressed as a percentage of the amount borrowed. When you borrow money, the lender charges a fee for providing you with the money over a period of time. What you actually borrow is called the principal. Interest goes to the financial institution so that they may cover the administrative costs that go along with lending money, as well as generate a profit. They, in turn, pay interest on the savings accounts of their customers. Your primary goal as a borrower is to pay the lowest interest rate possible.
There are many factors that are considered when a lender decides on an interest rate for you. First, your risk profile is considered. If the lender feels that you are of a particularly high risk group, then they will want to charge you a higher interest rate. This will compensate for the risk that they feel they are taking. If you fit the profile of other customers that have left loans unpaid, then you will be a higher risk. They will look as your history of borrowing and repayment. Your credit score is taken very seriously. They also look to see if you make other loan and credit card payments on time.
The term of the loan is very important in determining the interest rate that will be charged. Short-term loans generally have a lower interest rate. This is due to the predictability of short-term market conditions. Lenders take into account inflation, interest rate fluctuations and the economy as a whole. Because longer term economic conditions are much harder to predict, lenders charge higher interest rates for longer term loans. If interest rates increase to more than lenders charge their borrowers, they would eventually end up losing money on the loan.
Another risk factor for lenders is collateral or security. If you offer up your home as collateral, then you will usually get a lower interest rate than if you only have credit cards. Credit cards are subject to fraud and increase the risk factor for the lender. Mortgages usually have a lower interest rate because a home is a tangible asset.
The last thing that lenders are concerned about is inflation. Changes in the economy that cause prices to rise, is called inflation. You won’t be able to buy nearly as much with the same amount of money years down the road. Therefore, lenders factor in what they anticipate inflation to look like in the future when they figure your interest rate.
You can’t influence what the lender will consider, but you can shop around. Find the best loan for you that you can pay off in the shortest amount of time. Ask for lower interest rates than you are offered. Banks, credit unions, government lending and mortgage companies are options when shopping around. A payday loan may also be a good short-term solution. Make your payments on-time and keep a good credit history to better your chances of low rates in the future.