What is the Right Interest Rate?



Interest on Borrowed Money

Interest is price paid to borrow money. It is an amount of money paid for the use of borrowed funds. Interest can be thought of as the cost of borrowing money.
Interest is the compensation to the lender for the risk of lending money.

What is an Interest Rate?

Interest rate is the percentage of the principal that is paid as a fee over a certain period of time (typically one month or year).
Interest rates vary from loan to loan and borrower to borrower. The interest rate depends a lot on the borrower’s ability to repay the loan on time and according to the established loan repayment schedule.

Choose a Benchmark (Market) Interest Rate

Whether it is the Prime Rate for short term loan or a Mortgage Rate for a home loan, Auto Rate for an automobile loan, etc., determine what market interest rate that you would like to use for your individual loan. Then consult Bankrate.com to choose the exact number (interest rate) to use for your loan's benchmark interest rate.
If the borrower is has a good credit rating use a number very close to the benchmark rate. If the borrower has a poor credit rating use a number higher than the benchmark rate.

What Factors Determine the Interest Rate

Normally, the borrower’s credit worthiness is the most important factor in determining the interest rate. The lower the borrower’s credit rating, the higher the interest rate. The better the borrower’s credit rating, the lower the interest rate.

The following are the important factors that will determine the interest rate payable on your loan:

  1. Do you make timely payments on your existing debt? The punctuality of payments is a major factor in deciding the interest rate applicable to your loan. If you’re past payment records indicate timely and punctual payments of existing debt, then you can negotiate a lower interest rate for future loans.
  2. How much are you paying on your existing credit lines? If you currently paying just the minimum amounts required, it is likely that your credit rating will be negatively affected.
  3. What percentage of your existing credit lines are currently utilized. If you are utilizing close to 50% percent of your existing credit limits, then your credit rating is negatively affected and your interest rate will be higher.
  4. Your income is also an important factor in determining your interest rates. The reliability of your future income and what percentage of it is dedicated to debt payments has a significant effect on your interest rate. The higher the amount of your income that is already earmarked for existing loan payment means that you will have to pay a higher interest rate on all new loans.

Be aware of Usury Laws

Usury means an illegal or excessive interest rate. Usury laws change from state to state. A summary of Usury Laws by State can be found at: Usury Laws.

Be aware of the Applicable Federal Rate (AFR)

The IRS will has established interest rate guidelines for personal loans. If the interest rate is too low, the IRS may classify the loan as a taxable gift. For more information on the Applicable Federal Interest Rate, read the article on the Index of Applicable Federal Rates (AFR) Rulings.