Getting low interest rates is possible. You only need to know what to do. Let me start this article by explaining what interest rate means. Interest rate is the proportion of the amount charged by the lender on the outstanding balance of a loan. This is usually expressed as a percentage on an annual basis. On the other hand, it can be defined as the ratio of amount charged by the lenders on the loan made available to another person called borrower for use so that the person(borrower) can repay in a future time. Interest rates are usually charged on an annual basis. However, when the period involved is less than one year, the interest will be calculated on a pro-rata basis. Interest can be income or an expense. It is income to lenders while it represents an expense to the borrowers. Lenders will naturally want the interest rates to go up while borrowers will want it the other way round. The higher the interest rates, the more income to lenders and more expenses to borrowers.
Difference Between Interest Rates and Apr
It is important that you know the difference between interest rate and annual percentage rate (apr). I will like to use mortgage loans for illustration here. If you want to borrow mortgage loan, you will get to understand that there are other fees you will need to pay besides the interest expenses. These fees include originating fee, closing costs, discount points and broker fees. When all these costs are added to the interest expense and then expressed as a percentage of your loan on an annual basis, the rate you get is known as annual percentage rate (apr). If you are comparing costs of borrowing loans, focusing on just interest rates may not give you a clear picture of the total costs of such loan. Some lenders usually advertise low interest rates with the aim of winning customers. Interest rates may not be the true representative of the costs of the loan. By the time you are told other fees you will need to pay, you will realise that the loans which appear cheap may not actually be that cheap.
Interest rates are usually lower than apr. That is why lending institutions will choose to advertise interest rates instead of apr. Nevertheless, interest rates still form a major element you need to watch out for when you want to obtain a loan, line of credit or credit card. It can determine whether you will be able to pay back a loan or not. Interest rates on loans contribute immensely to how much you will need to be paying monthly on your loan.
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How are interest calculated?
Basically, interest can be calculated on a simple interest or compound interest basis. When interest is based on a simple interest rate, it is very simple to calculate. All you need to do is to multiply the loan amount by the interest rate. However, interest rates are usually expressed as a percentage of the loan on an annual basis. If the loan period is not up to one year, you will need to pro-rate the interest based on the number of months covered. For instance, if you borrow $2,000 at an interest rate of 5% per annum, the interest for the whole one year will be $100. But let’s assume that the loan is just for 6 months, then interest will be calculated by dividing the $100 by 12 months and then multiplied by 6 months. This will give you $50 interest.
In the case of compound interest rate, the interest is usually charged monthly on a pro rata basis. The interest will then be added back to the principal. At the end of each month, the interest rate will be applied both on the principal and the accumulated interest. At the end of the loan period, the borrower will pay higher interest when compared to the amount payable if simple interest is used. The table below shows how compound interest rates work.
|Month||Loan||Interest @ 5% p.a||Loan Balance|
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I believe you could see the difference in the interest calculated using compound interest. Even though the two interest rates are the same 5%, the interest amount increased to $50.52 and $102.32 for 6 month and 12 months periods respectively. This is against $50 and $100 for 6 month and 12 months periods when simple interest was used. You can just imagine if the amount involved is large and the loan is for a longer period, say ten years. That is why lowering interest rates on your loans will be a good idea. You can use interest rate calculator or interest rate formula to compute your compound interest amount.
Compound interest formula is: A = P (1 + r/n) (nt)
A: This represents the future value of the loan (interest inclusive)
P: This represents the principal loan amount
r: This is the annual interest rate expressed in decimal
n: This is the number of times the interest is compounded per year
t: This is the number of years the loan will last
Once you have gotten the future value of the loan using the compound interest formula above, you can now deduct the principal loan amount from it to get your compound interest.
How to lower your interest rates
Have you ever wondered why two people can be offered two different interest rates on the same type of loans? It is not that the lender likes one person than the other. When it comes to loans, there are certain criteria that lenders will like to consider before deciding on the interest rate you may need to pay on the loan you seek to get. If you desire to enjoy low interest rates on almost all your loans, there are various steps you may need to take. However, some may be specific to a particular type of loan.
- Know current interest rates: The starting point is for you to define the type of loans you want to borrow. All loans have their range of interest rates. For instance, interest rates for mortgage loans and auto loans cannot be the same. So, you should familiarise yourself with current interest rates so that you can know what is obtainable in the market. That will give you a fair idea of what to expect. People say that ignorance is a disease. If you know what the current interest rates are, you can easily tell whether certain interest rates offered you are reasonable or not. Also, knowing the current interest rates can help you decide whether it is the right time for you to borrow or may be you still need to defer it. Find below the current mortgage interest rates. The table will help you know the interest rates trend. You can tell whether the rates are rising or falling. We are still working towards making current auto loan interest rates and current home equity interest rates available to you on a weekly basis.
|3-month trend||30-year fixed||15-year fixed||5/1 ARM||30-year jumbo|
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- Shop around: With many interest rates comparison or review websites, it is easy to shop around for loans. All you just need to do is to fill out a form once with your details on their websites. Then your request will be sent to many lending institutions at the same time. You can be sure of receiving offers from different lenders. These offers will be based on the same information you provided about yourself. This makes comparison very easy. You will know that you are comparing apples with apples. However, you need to understand that you are not only comparing interest rates, you also need to compare other incidental costs. A lender with the cheapest interest rate may not make the best offer. If you want to shop around, it is always advisable to do this within a space of twenty to forty five days maximum. This will make credit bureaus to treat the inquiries on your credit in this regard as just one so that the inquiries will not hurt your credit score unnecessarily.
- Improve your credit score: One of the criteria lenders use in determining the interest rate application to individuals is the credit score. If you want low interest rates, you may need to first work on your credit score. If you have not been paying your card balance or making monthly payment promptly, this will definitely hurt your credit. Late payments or default can stay as long as seven years in your credit report. In order to improve your credit score, you need to start making your payments on time. With time, the effect of defaults will not be too much on your credit score again, even though it still appears in your credit report. Your credit history contributes to 35% of your credit score. Therefore, it makes sense to focus more attention to this area.
- Get balance transfer card: If you are carrying balances on your cards and you feel that the interest rates on the cards are quite too high, you may choose to get a 0% apr balance transfer card. This can help you save interest cost especially if you can pay off the card debts within the 0% introductory apr period. However, you may need to pay a transfer fee on the amount you are transferring. Therefore, you need to compare the fee you will need to pay with the interest you are trying to save and ensure that the savings outweigh the costs to you.
- Request for lower rates: There is no crime in asking. It is better to ask and be declined than to fail to ask for something you could have enjoyed. If you ask your lender for a lower interest rate, you may be surprised that the request may be granted. Some lending companies don’t like losing their customers. Instead of transferring your debts to another company, they would rather prefer to reduce your interest rate so that they can be sure of steady income from the interest you will be paying to them on a monthly basis.
- Get a stable job: If you don’t have stable employment or a job that pays you well, most of the interest rate offers you will be getting will be high. Lenders believe that if you don’t earn sufficient income, you may have problem paying back your loans. So, lending to you will be considered a risk. This will make them to jerk up their interest rates in other to compensate them for this additional risk. But if you have a stable job and possibly with very good income, lenders will be assured that you will be able to pay back your loans. This assurance can make them to lower the interest rates on your loans. However, you may need to negotiate with your lenders after you must have made payments for several months consistently.
- Maintain low debt-income ratio: How is your debt profile? Do you know that the amount you owe constitutes 30% of your credit score? No lenders want to give new loans to somebody who is already having a large amount of debts on his neck. What constitutes large amount of debts is relative. Lending institutions will like to compare the debts you owe to your income. The proportion of the debts you owe in relation to your income is called debt-income ratio. This is usually expressed in percentage. If this ratio is too high, you may find it difficult to obtain additional loans. At best, if you get one, the interest rates they will be offering you will be very high. If you want lower interest rates, you will need to pay off part of your debts or increase your income without taking additional loans. This will bring down your debt-income ratio. This may help you improve your credit score by few points.
- Increase your down payment: This is applicable to people seeking for low mortgage rates. A person making forty per cent down payment will likely get cheaper mortgage rates compared to another person making just twenty per cent down payment. The reason is that, it takes less risk on the part of the lender to finance a mortgage of forty per cent down payment than that of twenty per cent down payment, all things being equal.
- Opt for adjustable rate mortgage: You can get your home financed either by fixed rate mortgage or adjustable rate mortgage. Each of them has their own advantages and disadvantages. But in the context of this article, those people that are seeking low mortgage interest rates may opt for adjustable rate mortgage as it usually comes with low interest rates at the initial stage. Adjustable rate mortgage will only work for those who that don’t intend to stay long in their home. It may be that they want to sell the property within a short period. So, before the low interest rate period expires when the lender will possibly increase to new interest rate, you must have sold or moved out of the house.
Benefits of Low Interest Rates
- Affordability: Low interest rates makes loans affordable for consumers. There are people who will like to own their own home or car if only they can be granted low interest rates.
- Savings: Interest is an expense. It reduces your disposable income. If you can get a low interest loan, the money you would have spent paying the interest can be channelled to other important things such as investment in mutual fund. The amount may seem very small, but when it is compounded for several years, it can make a difference in your retirement planning.
- Easy Repayment: Repayment becomes very easy for you. High interest rate is one of the reasons people default in their monthly payments. If the interest rate is low, large part of your monthly repayment will be applied to the principal. This will help you pay off your loans within a shorter period. You will have a good payment history and this will improve your credit score. With good credit score, you will also qualify for cheap insurance rates.