Have you ever wondered how bankers make money? Financial institutions loan out money to others. Lenders charge fees and interest rates to pay for the service of financing individuals, organizations, corporations and governments.
Interest rates are the price of money.
A very important element of finance is risk management. Why are some people charged higher interest rates than others? The financial institution sets interest rates based on a number of factors.
The financial institution wants to recover the value of its money. Therefore, it must make loan interest rates high enough to be able to account for inflation. If the inflation rate is 3%, then the interest rate should be above 3% to be profitable.
You might have noticed that those with good credit scores pay lower interest rates. Another part of the interest rate is based on creditworthiness. Banks have determined that good creditors are more likely to repay their loans.
Those with bad credit are less likely to repay their loans. Therefore, they are charged higher interest rates. This is meant to compensate for higher default rates.
Annual Percentage Rate
It is important for you to carefully read the terms and conditions of your loan agreements. For many credit cards, you have an annual percentage rate (APR) listed. What is this?
This is based on a full year – this is what you would need to pay for an entire year. Compound interest is the addition of the principal plus the interest rate. When you have a credit card bill, the principal is what you spent on the merchandise and the interest rate is what the credit card issuing bank is charging.
Good Credit Score
A good credit score provides you with numerous options. Generally, you are more likely to qualify for various loans. Some companies won’t even consider your application, unless your credit score is higher than a certain number.
Besides being offered new types of loans, you can also have higher acceptance rates when you have a good credit score. You can also qualify for lower loan interest rates with a better credit score.