What Determines Your Interest Rate
Interest rates are often seen as the ‘cost’ of a loan so having the lowest possible is attractive to borrowers.
We take a look at what determines an interest rate.
- The interest rate is expressed as a percentage of the amount you borrow, therefore, the more money you owe, the more dollars the interest rate represents
- Lending institutions (lenders), like banks, calculate interest rates based on risk and generally, the higher the risk to the lender, the higher the interest rate
- To calculate this risk, lenders view applicants’ all important credit files
- A long employment history and residence history, previously repaid loans and many other things can help you get a low interest rate
Here are some things that lenders typically consider when calculating an interest rate…
Your credit file
Aka., a credit report, these files generate when you first apply for credit and you’re over 18. For example, you get a phone plan or utility bill in your name.
Credit files, often a PDF, contain details such as
- Credit enquiries (when you apply for credit)
- Personal information like your address and DOB
- Any missed payments of past and current credit (temporarily)
- Details of businesses which you might own or direct
- Other various financial information
- Your credit score
A credit score is a key ingredient in calculating your interest rate. Usually out of 1,200 or 1,000, a credit score rates a person’s ability to repay a loan. The higher, the better.
Things like multiple credit enquiries (loan applications), late or missed repayments on loans and utilities, among other things, can reduce a credit score.
On the other hand, repaying a loan on schedule can increase a credit score.
Reporting agencies like Equifax are responsible for credit reports.
Tip: repayment defaults can dramatically affect a credit score in a negative way. A default is typically recorded on your credit history if you miss a payment which is more than $150, and if it becomes more than 60 days overdue.
Before the default is recorded, the credit provider must send you two written notices: the first requesting payment, and a second a notice that the debt will be reported to a credit reporting body.
A standard default will typically remain on your credit report for 5 years. A bankruptcy stays on your file for 7 years.
Solution: if you feel that you might default on a repayment, contact your lender. Often, lenders can come to agreements or find solutions to avoid putting a default on your credit file. Remember, lenders are businesses and, like all businesses, want to provide good customer service.
Other considerations that determine an interest rate
Shopping for finance - negative effect
This means applying for multiple loans just to compare rates. It may be a good idea for a lot of purchases in life, but not finance.
Each time you formally apply for credit, it’s recorded on your credit file and can negatively affect your chances of approval and/or the loan amounts you’re seeking. This is especially true with multiple enquiries over a short period of time.
Tip: using a broker is a great option - they’ll be able to find the best options suited to your circumstances without affecting your credit file until you agree on an option.
A long credit history - positive effect
This means the time since you first applied for credit or your credit file was first generated - the age of your file. Usually, lenders prefer borrowers who have a longer credit history as there is more data to go by.
This means young people may attract higher interest rates than older borrowers with a long history of credit repayments.
Tip: if you’re unsure when your credit history began, check with Equifax via the link above. Remember, it will not affect your credit file by simply viewing it.
Previous successful loans - positive effect
If you have successfully applied for and honored a loan in the past, it demonstrates that you will be able to do this again in the future.
In fact, some people choose to take out a loan when they’re young in order to build a credit history. This can allow them to borrow larger amounts in the future and increase approval chances.
The better your loan history, the higher the chance you have of securing a loan with a lower interest rate.
Stable employment and residence history - positive effect
Having a stable employment history and steady residence is reviewed as credit strength.The number of different employers and homes (addresses) you have had over the few years is taken into consideration for the formula for your interest rate.
The longer you’ve lived at your current residence and the longer you’ve been with your current employer, the better.
This extends to stability at your current business address if you are using the finance for business purposes. The greater stability you present, the less of a risk you are to a prospective lender.
Tip: if you’re not sure, check with a broker to find out whether you are able to get good rates on a loan right now, or whether you might be better waiting for a few months to improve your credit application.
Age and type of vehicle
If you’re planning to buy a car on finance, generally, the newer it is, the lower the interest rates it will attract.
The mileage, make and model also come into play as lenders look at vehicles that hold their value. Lower risk means lower rates.
Despite this, getting approved for an older vehicle and/or a rare one or one with high mileage is very doable, even more so if other criteria, like the above, are met.
Tip: think about the type of vehicle suited to your lifestyle and put needs over wants to avoid any car buying mistakes. There are often many products from various manufacturers to select from.
Deposit - positive effect
Having a deposit can dramatically increase your chances of approval and attract lower interest rates.
A deposit also means you might need to borrow less in order to buy the vehicle you’re looking at. This is great as a lower borrow amount means lower repayment amounts.
Different lenders, loan amounts and borrower profiles all have an impact on how much difference a deposit will make.
Contact a broker if you’re thinking about applying for a loan in the future and they’ll tell you how much of a deposit you might need to attract lower interest rates.
It’s surprising how much of a difference only a few months of savings can make.
Tip: if possible, try to set aside a percentage of your income each paycycle for a while and save up a deposit. If you’re selling or trading in an existing vehicle in order to purchase a new one, this can act as a deposit too.
Other assets - positive effect
If you own other assets outright like a car, boat, caravan or even a trailer, it can strengthen your profile because you have a higher net worth.
Furthermore, if you’re a homeowner, it can also strengthen your profile regardless of how far into a mortgage you might be. That’s assuming you don’t have any missed repayments of course.
Clean bank statements - positive effect
When a lender calculates an interest rate, they sometimes ask to look at an applicant’s bank statements - with the applicant’s permission of course.
This is to get an idea of spending habits and to make sure the applicant has surplus income to make loan repayments.
Things like regular gambling, large cash withdrawals or a generally expensive lifestyle can impact interest rates and chances of approval.
Tip: in the lead up to taking out a loan, ensure that your bank statements are in good shape with minimal cash withdrawals, gambling or other spending habits that a lender might deem as risky.
Get the best rates
If you’re thinking about finance, take a look at the tips above and work them into your spending habits.
Even applying one to your routine can make a big difference in a positive way.
Speaking of Positive, the team is here to help.
With our extensive lender panel, years of experience and large team of professional brokers, we’ll be able to match your lifestyle and circumstances with great tailored options.
Even just to find out where you stand, don’t hesitate to give the team a call or start with a quick quote (it only takes a few seconds).