How Lenders Set Their Interest Rates and How to Beat Them

While there are a lot of factors that go into choosing which type of loan you go with, the interest rate is definitely one of the most important. A loan with a 2% interest rate will be much cheaper in the long run than one with a 5% interest rate.

Then again, have you ever wondered how interest rates are set and chosen? If so, this article is perfect for you. We will not only look at how official interest rates are set, but also how lenders choose what rates they give their borrowers. We will also end the article by looking at some tips to help you get the best interest rate possible on your next loan.

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How Are Official Interest Rates Set?

Official interest rates are set by the central banking institution of a country, which is the Federal Reserve System in the USA. They determine the rate that banks charge each other for overnight lending and also implement different policies to make sure that prices remain stable. They also ensure there is a suitable supply of money in the country. These policies are what can alter the base rate. The rate they target will depend on many factors.

Simply put, it is the central banking authority that has the power to set the official interest rates. From there, think of the economy as a long chain of interest rates. The official rate set by the government will influence what the banks give to clients, which will impact what other lenders provide for you.

How Does a Lender Decide What Interest Rate to Give a Borrower?

Now you know about how official interest rates are set, but what about the interest rate that we get when we apply for a mortgage or other type of loan? Well, as mentioned earlier, these are directly related to the official interest rates. If the official rate is higher, you can expect to pay more, as a lender also had to pay more.

However, what sorts of factors go into deciding whether you will get a high or low-interest rate when you borrow? There are a few, and we will take a closer look at them now.

Credit Score and Credit Report

Of course, if a bank or other lender is going to give you a loan, they want to know that you have been able to handle debt in the past. One of the best ways to do this is to refer to your credit report. Your credit report is a statement that will list your current and past debts, how good you have been at paying them off, and more. Your credit score is a three-digit number that provides a quick and easy-to-understand snapshot of your credit health and history. The better your report (and the higher your score) the better interest rate you are likely to get as you will be seen as less risky than other borrowers.

Want to see how your credit score is calculated? Check out our infographic.

Bank Statements

In addition to your credit health and history, your lender might also want to know about the health of your finances. Your bank statements will show how much money you have coming in every month, as well as how much you spend, as well as how much is in your accounts currently. This will give them a good idea as to how good you are with finances and what you will be able to afford in terms of loan payments.

Debt-to-Income Ratio

You can calculate your debt-to-income ratio by taking all of your debt payments each month and dividing them by your monthly income. The number is one way for lenders to see if you are a good candidate for a loan or not. If a person has a high debt-to-income ratio, they are likely to be the ones to run into issues when it comes to making repayments. This is because they already have a lot of their income going to debts every month and adding more debt to that can be a recipe for late or missed payments.

Click here to learn how consumer debt can affect you.

Lenders might take other things into account of course, but these three factors will generally have the biggest impact on how lenders decide what interest rate to give borrowers. So, make sure that all of these documents and numbers look good before you apply for a loan, as it will definitely help you.

How to Get the Best Interest Rate Possible From a Lender?

Now that we know how interest rates are set and how lenders choose what rate they give borrowers, how can you find the best interest rates? First and foremost, you should be sure to shop around for different lenders. Many different ones will offer different rates, so visit a few different places and see what they are offering. Also, don’t be afraid to negotiate. You may need to visit a number of places until you finally find the right one, so be patient.

Improve Your Credit

Next, you should look to ensure that your credit report and credit score are in good condition. Getting a great interest rate is difficult if your credit is spotty, so you want to improve your credit (at least a little) before you apply for a loan. In order to help your credit score and credit health rise, you should keep your credit utilization low and ensure you are making payments on time.

For some ways of improving your credit score today, be sure to look here.

Have a Steady Income

You will also likely need to prove that you have stable income when you want to get the best interest rate. They will want to see that you have been employed and make enough money to afford the payments on the loan you are applying for. If you have a stable job and have been there for a while, it will go a long way in instilling confidence in your lender.

Here’s how to get by without a steady income.

Final Thoughts

Getting a good interest rate is all about exploring your options and making yourself the most impressive and attractive applicant possible. But, of course, it’s still up to you to do your research and find the best possible lender for your needs. If you’re currently in the market for a loan and are interested in being match with a competitive rate, Rebound Finance can help.

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