The interest rate is the fee a financial company charges the borrower for using the loan, expressed as a percentage of the borrowed or principal sum. While different financial institutions charge varying rates of interest, the precise figure charged depends on several factors such as;
• The loan amount
• Duration or term of the loan
• The borrower’s income
• The borrower’s other financial commitments
• The credit scores and history
• The nature and value of the security
The term of the loan
Interest rates vary due to effects of inflations and environmental factors. It is easy to predict the fluctuations in the short-term, but almost impossible in the long run. As such, short-term goals tend to attract lower interests than long-term goals, because the market conditions are unlikely to change much. Long-term goals, however, involve a lot of market uncertainties and is likely to suffer interest rate fluctuations thereby attracting a higher interest rate.
The loan amount
Since the interest rate is a percentage of the loan amount, a borrower of a large sum of money will pay a more substantial sum compared to someone who takes a smaller amount. Smaller loans, however, attract a higher annual percentage rate (APR) than larger loans.
The borrower’s income
A person’s income level also influences the interest rate in that, how much a person earns determines the monthly payments he or she can make. Most lenders use the debt-to-income ratios to arrive at this figure. A borrower with low-income is likely to attract much more interest rate than a person with expendable income. It is worth noting that income here does not refer to the amount a person makes but rather a percentage to which the revenue relates to borrower’s total debt.
The borrower’s other financial commitments
A person with other financial obligations such as mortgages from other financial companies attracts more interest in comparison to an individual with little or no debt. A perfect illustration is a person who takes a second mortgage loan. The second loan will attract a higher interest than the first one due to the associated risks.
The credit scores and history
Money lenders use a person’s credit score and history to decide whether an applicant qualifies for a loan or if they are a credit risk. In most case borrowers with a lower rating face challenges in getting funding. However, some brokers do advance credit facilities to the applicants with unfavorable score ratings albeit at a higher interest rate.
The nature and value of the security
The type of property a borrower offers as security also determines the amount of interest rate one pays. For instance, unsecured loans tend to attract a higher interest than secured loans. Similarly, interest charged on a loan secured by fixed tangible assets like a car or house, is lower than that of intangible less safe collateral like credit cards.