What Determines Your Interest on a Loan?

What Determines Your Interest on a Loan?

Getting a low interest rate is helpful for a lot of people who are planning to borrow money from a creditor, such as a bank. There are a lot of factors that determine the interest rate, but in general, the following five factors determine interest on your loan:


  • Your credit score
  • The loan amount
  • Your down payment amount
  • The loan term
  • The current national interest rate

Aside from the factors mentioned above, other factors might affect the interest rate of your loan. While there are factors that you can control and fix in an attempt to lower your interest rate, there are also factors that are beyond your control yet still affect your interest rate.

Determining the Interest Rate

If you are planning to get a loan in the future, you must get familiar with different factors that determine the interest rates. This can help you make sure that you get a low interest rate when you borrow money from a creditor. 

Factors You Can Control

There are some factors that you have full control over and can fix within a specified period. For example, if you currently have a low credit score, then it is not advisable to get a mortgage, as you will get high home mortgage rates from any banks. 

If you want to lower your interest rates, then you should check the following and try to increase or decrease certain aspects before you officially take out a loan. 

Credit Score

A higher credit score gets you lower interest rates

The number one determiner of whether you will get a high or low interest rate is your credit score. Simply put, your credit score shows your history of how well you paid for your past loans. A high credit score means you are more likely to pay your loan to the creditor than someone with a bad credit score is.

Loan Amount

A lower loan amount gets lower interest rates

If you are borrowing a smaller amount of money, your creditor may be more at ease lending you the money at a lower interest rate. However, if you are borrowing a significant amount, your creditor needs to make sure that they can still earn even if you suddenly stop paying in the future. That is why creditors increase the interest rate if you borrow a larger amount of money.

Down Payment

A higher down payment gets lower interest rates

The reason why people with higher down payments on a car or home get a lower interest rate is because the actual loan amount that you are getting from the creditor is also smaller. Aside from this, a higher down payment also shows your creditor that you can pay for the money you are borrowing.

Loan Term

Short term loans get lower interest rates

The simplest way to look at it is that short-term loans have lower interest rates but higher monthly payments. This is because, while you are paying low-interest rates, you are paying for the total of your borrowed money in a shorter period. On the other hand, long-term loans have a higher interest rate, but you also have lower monthly payments. 

Factors You Cannot Control

While there are factors that you can control, there are also factors that you have little control over. While they are uncontrollable, you can still wait for the best opportunity to take a loan. For example, you have no control over national interest rates, but it does not mean that you cannot wait a little longer until the conditions are more favorable for you. 

The following are interest rate factors, including home mortgage rates, that someone cannot fully control or affect. 

National Interest Rate

Lower National Interest Rate gets lower interest rates on a loan

Your country’s economy has a significant impact on your interest rates. For example, in the United States, the Federal Reserve will set national interest rates based on the supply and the demand of credit. If there is a higher demand for credit, interest rates will be higher. 

Loan Type

Different loan types have different interest rates

Interest rates today may differ for each type of loan that you want. For example, a mortgage loan will generally have a lower interest rate than a personal loan or a credit card. This is because the mortgage loan has collateral: If you default on your payment, your creditor can take possession of your house. This makes the mortgage loan less risky. 

Creditor

Different creditors have different interest rates

If you want to mortgage a house, it is recommended that you get the best mortgage rates from banks that offer low mortgage interest rates today. For example, U.S. bank mortgage rates between Bank of America and Wells Fargo have different home mortgage rates, and it depends on what type of interest rate you are going for to see what is best for you. 

While you can easily find another bank to borrow from, you must also remember that individual banks have different processing fees and requirements. Sometimes, you are stuck with a creditor that has a high interest rate because of your low credit score.

Interest Rate Type

Adjustable rates can increase or decrease while fixed interest rates stay the same

Another factor is whether your loan or mortgage has fixed interest rates or adjustable rates. If you opt for an adjustable mortgage rate, your current mortgage interest rates can be different from your mortgage rate in the future. The general advice is to get flexible rates if you think the national interest rate today will decrease in the future. Otherwise, get fixed interest rates.

Conclusion

Calculating interest on a loan can be difficult and tricky, but it is necessary to know your home loan interest rate so that you can prepare for your future budget. It is also advisable that you get the best home mortgage rates that a bank can offer to get the most of your money. Now that you know these factors, you can plan your loans in order to get the best mortgage rates and other type of loan’s interest rates for your future.