Interest Rate Determination

Many borrowers in their first experience securing a loan for a new home ,
automobile or credit card are unfamiliar with loan interest rates and how they are
determined. The interest rate depends on the type of loan, the borrower’s credit
score and if the loan is secured or unsecured.

In some cases, a lender will request that the loan interest be tied to material
assets like a car title or property deed. State and federal consumer protection
laws set legal limits regarding the amount of interest a lender can legally set
without it being considered an illegal and excessive usury amount.

If the loan includes interest payments, as most do, the terms will be spelled out
in the loan’s terms and conditions. Interest is either fixed fee or floating fee.

A fixed fee, or fixed rate, loan establishes an interest rates that remains
unchanged during the repayment of the loans. If you borrow money with a 4%
annual rate, you will pay the lender 4% a year on the balance due until the loan is
paid off. The amount of interest you pay will decrease over time as the balance is
paid down and the principal payment will increase. If you borrow $200,000 to
buy a house, the monthly payment will remain constant, but the portion of the
payment that goes to interest and principal will change each month as the loan is
balance is reduced.

Floating fee interest rates, also called variable rate loans, carry interest rates that
change over time. The amount of interest based on a benchmark rate, usually a
widely followed index like the LIBOR that changes regularly. Floating fee rates
are adjusted periodically and generally are only used in complex loans like
adjustable-rate home mortgages.