Six Factors that Affect Your Interest RateIf you’ve ever gotten a credit card or taken out a personal loan, you may have wondered how the issuer or lender decided on the amount of interest to charge you. Your credit history plays a big part, but it’s not the whole picture. There are a variety of components, both things you can control and things you can’t, that combine to determine your interest rate, and understanding how they work can help you secure your lowest interest rate possible. If you have an interest in interest, read on to learn more.

Factors out of your control

Interest rates are partly based on economic factors that shift over time. You may not have any sway over these, but once you know what to look for, you can watch for changes and take advantage of them.

Supply and demand: When you think of interest rates as a price for borrowing money, it makes sense that they would be affected by supply and demand. In lending, an increase in the demand for money, or a decrease in the supply of money held by lenders, will cause interest rates to go up. For example, if a lot of people started pulling all of their money out of their checking and savings accounts, that would decrease the supply of money that banks have to lend to borrowers, which would likely raise interest rates at those banks. Conversely, a decrease in the demand for money, or an increase in the supply of money, will lower interest rates as lenders try to attract more borrowers.

Inflation: Inflation is when the prices of goods and services rise, which decreases the purchasing power of money. Inflation can be good for people carrying debt, since it lowers the value of each dollar you owe, but by the same token it’s terrible for lenders. If the money a lender receives has less value than the money it originally lent due to inflation, it’s going to raise interest rates to account for the difference.

Federal funds rate: The interest rate that financial institutions charge one another for short-term loans is called the federal funds rate. It’s determined by the U.S. Federal Reserve, which uses the federal funds rate as a lever to help balance the economy. When the economy is slow, the Federal Reserve can lower the federal funds rate to encourage more borrowing, and when the economy is growing too fast, which can trigger large increases in inflation, the Federal Reserve can raise the federal funds rate to discourage borrowing. The interest rates that these big financial institutions charge one another creates a baseline that influences the prime rate, or the interest rate that banks charge to their best customers who have the lowest possible risk of defaulting on their loans, which in turn affects the interest rates for everyone else. So, when the federal funds rate goes up, as it recently did, interest rates go up along with it.

Factors in your control

These are all parts of interest rates that you can choose or change, and when you get down to it, they all have one goal: minimizing the lender’s risk. Lenders are looking for the safest loans possible, so by making yourself a less risky borrower, you can secure better interest rates.

Credit scores: Your credit scores impact many different parts of your life, but your ability to easily get new credit is probably the most obvious. Since credit scores are supposed to represent your creditworthiness, lenders look intensively at your credit scores and credit history to determine how risky you are to lend to. High credit scores, which you can get by paying your bills on time and keeping a low credit utilization ratio, indicate that you’re good at paying off your debts, so the risk of lending to you is low. If your credit scores aren’t great, though, the lender views you as less likely to pay back all of your loan, so it will charge you a higher interest rate to make up for that risk or just reject you outright. Fortunately, there are a number of ways you can boost your credit scores, and there are even services you can hire to fix your credit for you.

Loan amount and duration: While it may seem unfair that simply requesting a lot of money or a long repayment term can increase your interest rate, they both make a loan more difficult to pay back. Borrowing larger amounts of money means larger monthly loan payments, and taking out a loan with longer repayment terms not only makes the loan more vulnerable to inflation (note that this doesn’t apply to a loan with a fixed rate), but it also increases the chance that you’ll face some adversity in your life that may negatively impact your ability to pay the debt. To reduce these factors, before you take out a loan, ask yourself how much money you really need to borrow, and figure out the shortest possible amount of time in which you could realistically pay off the debt, even if it means making a few sacrifices.

Guarantee: A guarantee is an agreement to settle a debt in an alternate way in case the borrower defaults. Guarantees can take several different forms, such as collateral, cosigners or a personal guarantee, and adding a guarantee of some kind to a loan can reduce interest rates since they lower the lender’s risk. Before you add a guarantee to a loan to reduce your interest rate, be sure you thoroughly read and understand the agreement you’re making, as some of them can have unusual terms. Additionally, some types of loans have preexisting policies regarding guarantees, such as auto loans, which use the vehicle you’re buying as collateral, so you won’t always have a choice on whether or not to guarantee a loan.

Securing a low interest rate can turn a loan from a heavy burden into a breeze. To find out more ways to maximize your money, follow our personal finance blog.