If anybody ask me what is the most important factor regarding any type of loan, I would say it is the interest rate. This is because interest rate constitutes major portion of cost of loan and if a person is able to get any type of loan at lower rates, he feels himself at ease regarding to repayment. Interest rate can be defined as the rate at which the sum borrowed by a person is required to be paid back at fixed intervals, rate being compound or simple. Most of the lending institutions we find in the market like banks, credit unions etc provide loans at compounding interest rates and thus, a person has to pay interest on interest accrued also. Interest rates depend upon many factors especially which country you are in, see this example https://www.hsbc.com.au/home-loans/products/home-value/.
Factors affecting loans interest rates
Different types of loan attract different interest rates. Interest rate depends upon many factors. First is the security status of the loan, i.e. whether the loan is secured or unsecured. Since there is no collateral or security with a person in case of unsecured loan, lender charges high interest rates as compare to secured loans. Lowest interest rates are charged with respect of secured loans. Security is also of different types. Most preferred security of all the lenders is land or home. This is because it can easily be mortgaged in the name of lender and in case, a person does not make repayment of the loan amount, it can be sold to realize the outstanding balance. This is the reason why home loans, mortgage loans etc are among the lowest interest rate loans.
Unsecured loans like personal loans are among the costliest loans. These loans are generally provided for interest rates in the range of 14-20% as compared to secured loans that are provided for the interest rate in the range of 4-7%. Interest rates vary from one lender to another. Second factor affecting the loans interest rate is the term of loan. It is also called as repayment period of the loan. If the borrower opts for longer repayment periods, he is charged lower interest rate as lender is able to get income over a long period of time. Similarly, if a borrower selects short repayment schedule, the interest rate would be high, as the lender would try to get as much income as it can over the short repayment period. Third important factor that affects the loans interest rates is the credit score of a person. In some countries like United States, UK etc, lenders verify the credit score of a person before providing loan amount and charging interest. Credit score of a person is affected by his past repayment history. If a person has defaulted in making repayments, credit score would be less. Low credit score attracts higher interest rates as the lender is at risk while making loans to such people. Even if a borrower is providing adequate security for the loan, his low credit score results in higher interest rates.
Apart from the above, there are many other factors that affect the loans interest rates. These are income of a person, his employment status etc. While discussing about the loans interest rates here, payday loans cannot be left out. These short term loans, which are provided to a person up to his payday only, are among the highest rate loans. It is really surprising that a person has to pay interest at the rate of 350-700% for small amounts like $500. Such higher interest rates are charged because these loans are provided in less period of time, sometimes as less as one hour, and do not require any type of formality to be completed.
Since each lender is charging its own interest rates, as the interest rate market across the globe has become quite deregulated, it is advised that a person should make comparison of all the lenders so as to get the lowest interest rate. This would help him in saving some amount.
Interest rates charged on various types of loans are also affected by the interest rates charged by the government on various types of securities. For example, in U.S, prime interest rate for the federal government loans has been fixed at 7.25% for the month of January 2008. It was 7.35% in the month of December 2007. If other current money rates are seen in U.S, it is 4.45% for the 30 year T-Bond, 4.04% for the 10 year T-Note, 3.36% for the 91 Day T-Bill, 3.06% for the Federal Funds, and 6.17% for the 30-year mortgages. These rates affect various types of loans provided by the government at state and federal level. For example, Federal Student Loans are quite popular in United States. The interest rate on Stafford loans has been fixed at 91 day T-Bill interest rate plus 1.7% during the grace, in-school and the deferment periods. All the Stafford loans that were first disbursed on or after 1st July, 2006; the interest rate has been fixed at 6.8%. Similarly, during the repayment period pertaining to the Stafford loans, the interest rate is charged as 91-T Bill rate plus 2.3%.
Another aspect that should be clearly understood by the reader is the difference between the interest rate and the APR or Annual Percentage Rate. Interest rate is that rate at which interest is applied in the loan account and does not take into account various types of fees and charges levied by the lender. APR is actually the cost of loan in percentage terms that include interest rate also. It is quite possible that any lender is charging interest at the rate of 5% on the mortgage loans, but in terms of APR, it is 6.25%. This factor works quite importantly when a person is comparing rates of different lenders for a similar type of loan. If a person leaves a lender that provides mortgage loan at the rate of 5.5% but at APR of 5.75% and gets the similar loan from lender mentioned above at 5% interest rate but 6.25% APR, he is actually making higher payments towards repayment at the rate of 0.75% differential.