When a person borrows money, the lender earns money by charging a fee. The cost of borrowing this money is known as an interest rate. Each interest rate is typically expressed as a percentage of the total amount of money borrowed. Over time, the lender assesses this fee based on how long the borrower takes to repay the loan. The amount of money that is actually borrowed is referred to as the principal. The primary goal of every borrower should always be to pay the least amount of interest so that the money that is paid to the lender primarily goes towards the repayment of the money that was borrowed. Naturally, the higher the interest rate of a loan, the more the lender will earn.
So why don’t lenders charge everyone a high rate?
Fortunately for you, the consumer, competition keeps interest rates low and gives you the opportunity to shop around for the best loan to suit your needs. When a lender is deciding on an interest rate there are many factors they consider. Your risk profile is first. If you fall into a high-risk group based on your past financial activity and reputation you will be charged a higher interest rate.
Am I a “high-risk” borrower?
If you have borrowed money in the past and left loans unpaid or received merchandise or services that you agreed to pay for and did not, then you fit the profile of being a higher risk. Lenders will look at your history of borrowing and repayment. Your credit score will be a direct reflection of this. Since this rating is a direct reflection of whether you meet other financial obligations on time, potential lenders take it very seriously.
How is my interest rate determined?
The length of a loan or the amount of time a balance is outstanding is known as the loan term. Loan terms are commonly used to determine interest rates. Loans that are short-term are more predictable and therefore have lower interest rates. The economy, inflation, industry interest rate fluctuations are all taken into consideration and accounted for when lenders try to project what rates will be reasonable and lucrative for them. If rates increase more than lenders charge their borrowers, the lender looses money in the end which is bad for business.
How can my lender be sure I will repay my loan?
In the industry of loans and financing, just like everything else in life, there are no guarantees. There is certainly a degree of risk involved even with borrowers with the highest credit scores. Customers who have lower credit scores and are clearly a higher risk are often asked to provide some type of additional security that they will live up to their commitment. This security is known as collateral. A security or collateral is something that holds great value, such as a home. When a secure collateral is offered along with an agreement to repay the risk factor decreases significantly for the lender and the borrower may receive a much lower interest rate.
What is inflation and how does it affect my interest rate?
One final consideration for lenders is inflation. Economic changes cause prices to rise. For example, if a grocer pays a farmer $10.00 for a crate of apples and sells them at $2.00 per bag for a profit, he can not reasonably pay $20.00 for the same crate of apples and expect to make a profit selling them at the same $2.00 per bag. If the grocer’s cost increases, he must pass that cost on to his customers in order to stay in business. This principle, known as inflation, applies to every industry including the financial industry. Lenders also factor in what impact they expect inflation to have in the future in order to determine what your interest rate will be.
Shopping around is the best strategy when it comes to finding the best interest rate. You may not be able to influence what factors the lender will consider but you can absolutely ask for lower interest rates than what you are offered. Try to negotiate and remember that banks, credit unions, government lending, mortgage companies, and even payday loans as a short term alternative may be good options. To optimize your chances of being offered lower rates in the future be sure to make your payments on time and maintain LuxuriousCREDIT™!