What is An Interest Rate?

An interest is the amount of money/profit that will be returned to a lender based on the amount of principal lent out. This rate is calculated as a percentage and applies to the original principal amount lent. So, if a loan was issued for $10,000 with an effective interest rate of 20%, in a year the borrower will pay back $12,000. So, the 20% interest rate led to a $2,000 interest payment.

Why Do Interest Rates Fluctuate?

Interest rates fluctuate for a few different reasons. Interest rates can go up or down depending on a consumer’s credit score and the perceived risk of lending them money. This risk is higher for some individuals and lower for others. If a borrower previously failed to repay their debts in the past or had late payment this will typically negatively impact their interest rate and the terms of any loan offerings, etc. The opposite would also be true in that if a borrower maintains excellent credit history and keeps a low utilization rate and does nearly everything correctly, they’ll be actively rewarded for it and will qualify for lower interest rates.

Different interest Rates for Different Products

Different interest rates are offered for different financial products. A mortgage interest rate or any secured debt for that matter, will typically provide a much lower interest rate than a credit card for example. This holds true because credit cards are considered to be a lot riskier than a mortgage. If a borrower fails to repay what was borrowed the lender can come after the home and threaten to take it away. That is not the case with a credit card since it is not tied to any assets. However, lenders could still choose to sue borrowers and litigate on debts owed if they so choose. Although they don’t technically have assets they can take as collateral, they can still choose to take aggressive action on debts that are owed to them.

How Do You Get Better Interest Rates?

If you’re looking to borrow and you’re concerned about your interest rate on a big purchase, that’s very normal. However, besides maintaining good credit and trying to improve your credit score whenever possible, there aren’t too many options available to you. For the most part interest rates are determined by your credit score, debt to income ratio and market factors. If interest rates are high across the board, your credit score is not going to help you beat market rates. The FED Funds Rate is set by the Federal Reserve and market rates are a factor of the federal funds rate. Therefore, there’ only so much you can do to alter the interest rates you receive. If interest rates are high for everyone, they’re also likely to be highly for everyone else as well.

Without interest rates there would be a lot of ambiguity in terms of lending. Interest rates allow for lending to become a more defined process and therefore add a lot of clarity to the market place.