APR (Annual Percentage Rate) It’s the percentage that shows us the total cost (in %) of borrowing money from that lender. It includes interest rate plus additional fees, charges for the lending of the money. APR is used by borrowers to know how much a loan is costing them, compared to APY (annual percentage yield), which is used by investors to see their return from compounding. APR is useful when comparing different loan products. The nominal interest rate only gives us just the interest rate whereas APR gives us a more clear picture of how much it’s costing to take up the loan. ——————Fixed Interest rate (FIR)Vs Variable Interest Rate (VIR) The rate of interest is fixed for the lifetime of the loan in the fixed interest loans whereas the interest rate varies going up and down during the loan’s tenure after the initial period of 3-5 years. FIR is suitable for people who like the comfort of paying a certain amount every month with fixed monthly income and like to not bother with market conditions whereas Variable rate is suitable for people who think the market conditions will get the interest rates lower at times making the payments lower. In variable interest rate, the first 3-5 years of monthly payments can be lower compared to the fixed rate loans. ——————–How Interest Rates are determinedMany factors influence interest rates. The main factors are creditworthiness of a borrower, their credit history, government monetary policies, inflation rate, repo rate, etc. Creditworthiness and income are two factors mainly determining the interest rates while taking out a loan. Lenders often offer lower interest rates and higher loan amounts to people with great credit scores whereas people who have lower credit scores, typically under 700 may get higher interest rates with lower loan amounts. DTI is another factor in determining the interest rates. When DTI is above 50%, the lender may take more risk and increase the interest rates. ————-Impact of credit score on Interest rates. Credit score is a critical factor because it shows the lender the past history and the credit behaviour of the borrower. Interest rates can go crazy if the lender is not comfortable with lending or if the borrower is just meeting their minimum criteria. Higher credit scores give a positive sign to the lender that the borrower has been diligent with the credit. Negotiation Better Rates: The interest rates can be negotiated if the borrower has a stellar credit score and has a great reputation with the bank. ———How Lenders Use Risk Assessment to Set RatesLenders cater to a variety of borrowers with varying credit scores. So it’s not possible to give the same terms to everyone. For this purpose, the lenders use risk based pricing where the lenders check certain metrics of the borrower before lending and setting the rates. Main factors includeCredit score : Higher the score, lower the interest rate. Repayment History: Careless behavior or late payments or defaulting signals the borrower is a risky one. DTI ratio: Typically below 50% is the limit. Above 50% indicates that the borrower might default.
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