You know that low interest rates are better… but has anyone actually told you WHY?
Better yet, has anyone told you what rates are great, and what are ghastly?
It’s time for a crash course on interest rates and why you NEED to know where your personal situation falls.
Interest Rate: (noun) the proportion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding.
In simple terms. How much the lender gets to charge you for not having all of the cash up front. Or, as I like to remind myself of… “how much EXTRA I am willing to pay for this already expensive item.”
Here’s some average benchmarks. I use the word “average” very liberally–meaning that these are figures that most Americans across the board are paying for these products.
- New & Used Auto Loans: 4.27% – 4.46%
- Mortgages: 3.875%
- Credit Cards: 15.07%
- Personal Loans: 19.84%
- Student Loans: 4.66% – 7.21%
This part varies by jurisdiction, but the highest that most lenders can charge is 29.99%.
Now, most (but not all) lenders base their rates off two major factors.
- The borrower’s credit score. (The better your credit score, the better your rate)
- The length of the term. (The longer you finance, the higher your rate will be)
This is why having a solid credit score is important, because it affects the cost you pay to borrow money. How much does it impact you? Let’s find out.
I decided that you’re going to hypothetically buy a $10,000 car right now. You pick the make and model. Using BankRate’s Loan Calculator…
Loan #1: 60 months at 2.89%:
This rate is currently being advertised by my employer for those who have great credit scores. This score is typically 730 and above, according to Equifax.
- Monthly Payment: $179.20
- Total Interest Paid: $751.91
Loan #2: 60 months at 24.99%
This rate is a rate that I booked many auto loans at when I was a car salesman. Bad credit, no credit, or fair credit profiles. This is also in-line with Buy Here Pay Here lots who may disguise it by offering a low “rate” but with high fees that no other lender would ever charge you.
- Monthly Payment: $293.45
- Total Interest Paid: $7,607.28
Difference? One person paid $6,856.18 MORE to buy their car.
Same car. Same Term. Same Loan Amount. Different People.
Seriously. This isn’t a dramatization, fake figures, or written shock factor. This is something that happens thousands of times every single day. If your credit has had some bumps, straighten it out and stay on top of it. It is literally the difference between saving or spending thousands of dollars every year.
If you have a loan with a high rate, and you believe that your credit has improved since you did the loan, I strongly advise you to explore avenues of refinancing that loan with another lender. It can save you thousands of dollars. Likewise, approach your current lender and ask them to qualify you for a lower rate.
Look at it this way… The worst they can say is “no“, and nothing changes.
The best they can do is save you money.
This final point applies strongly to credit cards. You will likely see the following words with whatever rates/terms the lender wants to use at that time. What you DON’T see, is the truth behind them. Lucky for you, today…you will.
- 0% for X months: This means that your purchase will enjoy 0% rates for whatever amount of time they say. If you DON’T pay off your full balance before the time ends, you will be charged as high as 29.99% on the original balance, not the current balance.
- 6 Months Same As Cash: This is cute lingo for the top point. See above.
- Introductory/Teaser 0% Interest Rate: You will have 0% for a few months. Then it increases to the market rate, up to 29.99%, forever. And ever.
- 3% Balance Transfer Fee: They are going to charge you a 3% fee on the balance you transfer to this card, from another loan. Moving $1,000 over? You’re going to pay them a $30 fee for the privilege of doing so…PLUS the normal interest rate. Oh goody.
- 0% Balance Transfer For X Months: This is the same thing as the very first bullet point, except it applies to the amount that you transferred over from another loan.
Moral of this story, read your terms very carefully before applying and/or accepting a loan. You won’t save any money if you are paying high interest rates.
Yes… there are situations where getting a loan is wiser than paying cash. To name two scenarios, interest that can be written off in your taxes can be more beneficial than paying cash if you plan to invest it. Likewise, extremely low rates of 2% to borrow could mean that the cash you WERE going to spend can instead be invested in your 401k (or other avenues) and enjoy 6% returns. Consult with a financial accountant or attorney to see what is best for you, if you have an influx of cash sitting around.
Unlucky for me, that’s not my situation…yet.
Stay on top of your credit report every month…or at least once a year. Make sure there are no errors, omissions, or false reporting on it that may be dragging down your credit score. Don’t obsess over the credit score unless you intend to apply for a loan soon. Trust me. It doesn’t change very much each month, and you’re only going to stress yourself out.
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However, if you think you are going to apply for credit in the future, always do your research before you apply. Don’t just “take their word” for it. It’s YOUR money and YOUR life. No matter how friendly, trusting, or how much they make you feel like they’re doing you a favor… you are the only person looking out for yourself in business.
One final note. If you plan to apply for ANY form of credit, make sure you KNOW what a good rate for your credit profile is before you apply, and accept nothing higher.
The internet is your friend. Look up at least 5 lenders and see what you qualify for.
Added tip: I always get “pre-approved” by my credit union before I ever start car shopping. The salesperson isn’t interested in saving me money, he wants to sell me a car and feed their family. So does the credit card company, and all the other lenders.
Unlucky for them, you and I also want to save money and feed our own families.
Take responsibility of your money and educate yourself.
As a refresher, HERE is my recent entry on how to build credit.