How is My Loan Interest Rate Calculated?

There's a lot of talk in the media about interest rates, and consumers are more conscious of their rates than ever. But how is your interest rate calculated?

The interest rate that you qualify for depends on many factors, beginning with your credit history. You've probably heard a lot of buzz lately about the importance of checking your credit score. This is important to you for many reasons. Your credit report is essentially a report card on your financial background - what financial institutions you've done business with, how you've paid, if you've had any bankruptcies, how long you've had relationships with financial institutions, and payment histories are all part of your credit report.

Your credit report also comes with a FICO score. The FICO score is available for an additional fee. This score is in an indicator of what interest rate you qualify for. However, all of the other items on your credit report factor into the equation as well. For example, you may have a high FICO score but have few lines of credit. Having few lines of credit puts you in a riskier credit category and may affect the interest rate you qualify for. The amount available on your trade lines matters also, as do the limit on each account and your debt-to-income ratio.

After you consider your credit history other factors come into play. Car loans with longer terms usually carry higher interest rates. Similarly, loans for more than the amount of the vehicle you're buying may have a higher interest rate than if you borrow just the amount of the car. With many people trading in cars that have negative equity and/or adding features on top of the value of the vehicle, such as an extended warranty or insurance products, this is very common.

In a nutshell - get to know your credit report and consider the length and amount of the loan you need. Always feel free to ask your lender or the dealership that is arranging your loan to explain your interest rate if you have any questions.