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How do lenders decide what interest rate to charge?

How do lenders decide what interest rate to charge? As with most things a lender is just a person trying to make money so just like gas prices are determined by many factors including state and federal laws. Interest is determined by many factors.Some of those factors include what price people will pay. Obviously if a lender has enough competition charging less than him he will bring his interest down. Also if there are no borrowers looking for loans than the lender will bring his interest rates down to attract more borrowers or have a great starting interest rate to get you hooked. Some less scrupulous lenders will also have hidden fees that don't show up on their initial disclosure of the interest rate.

The Congress enacted a law called the Truth in Lending Act and it helps us have an equal way to measure different loan offers. Every lender must give you a truth in lending statement which is where the accurate comparison numbers can be found. This document must include 4 key points of information.

- Annual percentage rate or APR is the total effective cost of credit expressed as a yearly rate including fees and interest.
- Finance Charge - the dollar amount of interest if the loan is paid over its full term
- Amount Financed - the amount of credit actually available for the borrower's use, or the net amount of credit extended
- Total Number of Payments - the sum of the Finance Charge and the Amount Financed.

Some other factors include what your credit score is and how you have paid on previous loans
Some lenders charge less interest for home owners or if you are a member of their credit union. Making your payments on time and keeping your loan balances down are ways to increase your chances of getting a less expensive loan.

Here are five factors some banks use to make lending decisions.

1. Character What kind of borrower will you be? The best clue to your character is your personal credit history. Lenders always check to see how well you have managed your personal debt in the past.

What if you do not have personal credit history? Personal references, business experience and work history can sometimes substitute, but a strong personal credit history proves that you have the willingness and the discipline to repay past debts - and future obligations.

2. Credit

Lenders use credit-reporting agencies to look at your payment history with trade suppliers and other business obligations. We also look to see that your payments to other financial institutions are current.

The 3 main credit reporting agencies are:

Equifax Credit Information Services, Inc., (Equifax), Trans Union LLC (Trans Union), and Experian Information Solutions, Inc. (Experian)

3. Debt to income ratio.

The Debt to income ratio is a percentage of your income that is going toward your debts most banks like this to be less than 40%

4. Assets

Most banks want to know how you would be able to repay your loan in case there was a sudden downturn in your income. Do you have the capacity to convert other assets to cash, either by selling them or borrowing against them? Your ability to do this could include real estate holdings, certificates of deposit, stocks and other sources of savings that can be liquidated quickly.

5. Collateral

There are two kinds of loans secured and unsecured loans. With a secured loan, you pledge something that you own as collateral. It might be personal assets like certificates of deposits or stocks, or business assets like real estate, inventory, equipment or accounts receivable. Unsecured loans have higher rates of interest because they are more risky.

The amount of interest a lender can charge is different depending on the situation so do your homework to find out the best rate of interest for your situation.

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