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What Determines Your Interest Rate

May 27, 2008  |  Difficulty: Easy

What determines your interest rate may seem like a mystery, but there is an actual process. Here are the three main factors that influence your interest rate.

  • The Federal Reserve Discount Interest Rate.
The banks and other lending institutions get their money from the Federal Reserve Banks. They are able to borrow at a discount rate, set by the board of directors. This rate directly affects the Prime Interest Rate, which is what high credit commercial customers get on short-term loans. This means that for the most of us, we will get a prime interest rate, plus some amount of interest, depending on the lender’s consumer mortgages.
  • Your FICO Score and Credit Report.
The FICO score is a ranking of how likely it is that you will pay your bills on time. It basically pulls your credit history into one number.
The score is determined in a couple of ways. Some companies, called Consumer Reporting Agencies (CRAs), gather and sell this information, including your credit merit. Other factors include your career, your home location, bill payment history, and whether you’ve been sued, arrested or filed for bankruptcy. The most popular CRA is the credit bureau.
You can control your FICO score. Be sure to pay your bills on time and don’t abuse your credit cards or have excessive debt. It is also recommended to yearly check your credit score for accuracy and fraudulent activity. We suggest yearly because your score may lower with every check. This is why you should never let a lender run a credit check unless you are serious about buying.
  • Lender Business Factors.
Many don’t realize, but you (the borrower) have a lot of power. Banks and other lending institutions are in a competitive market. They compete for your business, so shopping for the best rate often begins a bidding war, leaving you with the lowest possible rate.
Check as many lenders as you can. Each lender has a special way of determining your rate, so one will definitely be better than another. Check lenders’ websites, as they can be helpful for quick research. If you have a good credit score, you have to power for lower rates.
Also remember, each credit check will slightly drop your score. So, be careful with how many checks you run. This is way online quotes are a good idea, as they typically won’t request a credit check until after giving you an initial quote.

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