Find Out What Determines Your Interest Rate

If you are like most of us, the actual process that sets interest rates is a bit of a mystery.

Well, we're here to help dispel as much of the myth and misinformation as possible. Here are the three main factors that influence the interest rate that you pay:

  1. The Federal Reserve Discount Interest Rate.

    This factor is why everyone watches the current Federal Reserve Chairman.

    Why would it affect you? Well, banks and other lending institutions get their money from the Federal Reserve Banks. They borrow money at a "discount rate". This rate is set by the boards of directors of the Federal Reserve Banks. The discount rate has a direct effect on the current "Prime Interest Rate".

    This is where you come in. The prime interest rate is the interest rate on short-term loans that banks charge their commercial customers with high credit ratings. What about you, the consumer? You will usually pay a rate based on prime, plus some amount of interest. This will depend on the lender's policy on consumer mortgages.

    Frankly, you don't have much control over this one. All of us have to live with the "prime rate", whatever it is.

  2. Your FICO Score and Credit Report.

    The FICO score is a method of determining the likelihood that credit users will pay their bills. It condenses a borrower's credit history into a single number.

    How is this score obtained? There are companies that gather and sell information about you, including many factors that affect your credit worthiness. These factors include where you work, your current address, your bill payment history, and whether you've been sued, arrested, or filed for bankruptcy. The companies that collect this information are called Consumer Reporting Agencies (CRAs). The most common type of CRA is the credit bureau. Potential lenders will get your credit report from a credit bureau.

    You do have control over your credit worthiness and the health of your FICO score. Pay your bills on time. Don't abuse your credit cards or become financially over-extended. Most of the best advice is common sense financial planning. However, you can also help yourself by checking your own credit information from time to time and ensuring that false or outdated information is changed and corrected. And don't let companies do a credit check on you unless you are ready to buy. Too many requests for a credit report can actually drive your FICO score down.

  3. Lender Business Factors.

    Here's where your ability to be a smart shopper can make a real difference. While banks and other lenders are in business to make a profit, they also exist in a competitive market. They are competing for your business, since you (the borrower) are the lifeline for their business (lending). This means that you can get a better price with a bit of legwork on your part.

    Always check out at least three lenders. Each lender will have unique guidelines for how they write loans, and one lender's guidelines could be more favourable to you than another. Also, some lenders are simply more competitive than others. If you know that you have a good credit history, you are a 'plum' client. Be sure to keep this in mind. It's to your advantage.

    A reminder: While you need to shop around, you don't need to have too many lenders requesting credit reports. Three or four is typically a safe number. If you request an on line quote from several lenders, they won't typically run your credit report until after they have made their initial quote to you.

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