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What banks look at when determine your loan rates and amounts

A bank looks at many different factors when determining a loan and the rates and amount of the loan. Before you begin looking at a loan, you need to ask yourself what you can afford or what the company can afford. To determine this, you need to make a list of all the expenses your company has like: rent, salary, utilities, entertainment, etc. Once you see what is left over, you can determine how much your loan amount should be.

Many borrowers are not aware of how a bank determines the loan rates or sets the loan amount. Obviously we know that loan rates are different for certain types of customers, but what type of customer are you? Let's explore what a bank looks at to determine your loan rate and amount when you are trying to get a loan.

A typical loan-pricing model is based that the rate of interest charged on any loan will include the following four components:


  • the funding cost incurred by the bank to raise funds to lend, whether such funds are obtained through customer deposits or through various money markets;

  • - the operating costs of servicing the loan, which include application and payment processing, and the bank's wages, salaries and occupancy expense;

  • - a risk premium to compensate the bank for the degree of default risk inherent in the loan request; and

  • - a profit margin on each loan that provides the bank with an adequate return on its capital.

Banks have to stay competitive as it affects a bank's targeted profit margin on loans. Many banks do not have high profit margins because of the intense competition in today's economy. Since there is such competition many banks use a form of price leadership in establishing the cost of credit. Basically, a base rate is established by the major banks and is the rate of interest charged to a bank's most creditworthy customers on short-term working capital loans. This is such a great system because it establishes the benchmark for many other types of loans.

Loan rates and amounts are determined by the risk factor a client brings. Defining the loan rate is difficult for loan pricing since many factors come into effect. Credit-scoring systems are the most popular type and can quickly compute a risk factor for a loan. The computer sets up a default premium with a specified cut-off point and group's potential clients into these groups. If your credit score falls into a certain category it can make a big difference in the loan rate. For instance, if you have a low credit score in the 500's, you will have a hard time getting a loan and if you do get a loan, you will have a hard time negotiating a loan rate.

The other factors that help determine the loan rate and loan amount are the collateral required and the term of the loan. If a loan is secured with collateral, the risk of default is lower. It is better to give a loan with a car as collateral than credit card debt. The more valuable the collateral the better your loan rate and loan amount will be. If you use your house versus a car, obviously it has more value and the bank will take that into effect.

Keeping your debts low and having a high credit score are the easiest way's to get a loan. Keep in mind what you or your business can afford each month so you do not get in over your head. Discussing options with a financial advisor is another way to look at loan rates and what you qualify for before heading to the bank.

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