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When you take out a loan of any kind, whether it is a mortgage, Personal loan, a car loan – or open a new credit card, you’ll pay interest on the borrowed money until you pay it off.

When lenders review your financial statements, they give you an annual percentage, or APR, depending on the type of loan, your credit rating and your risk profile. The higher your score, the lower your APR and the less you pay over time. On the other hand, if your score is lower, lenders might be worried about your default, so you will have to pay a higher interest rate since you are considered to be riskier.

Interest and APR are simple concepts in theory. But knowing what APR to expect when applying for a personal loan, mortgage, car loan, and / or new credit card is another story.

To help make sure you’re getting the best APR, we’ve broken down the top factors lenders look at when deciding what interest rate to charge you.

Why and how banks charge the APR

When deciding which APR to charge their customers, banks use the preferential rate as a starting point. The prime rate is determined by the Federal Free Market Committee and is about the lowest rate you can expect on mortgages and certain other types of loans if you have a good or excellent credit rating. In other industries, such as credit cards, lenders add an additional margin to the prime rate.

For example, the Citi® Double Cash Card offers a variable APR ranging from 13.99% to 23.99%, which is well above the prime rate of 3.25% (as of October 2020).

But it’s not all bad news: just like you’d be chasing the best price on a pair of shoes or getting a good deal on new furniture, you can also buy loans and credit products with a lower APR.

Learn more: Why are credit card APRs so high?

Factors lenders take into account when determining your interest rate

When shopping for a low interest loan or credit card, remember that banks are also looking for reliable borrowers who make timely payments. With that in mind, financial institutions will look at your credit score, income, payment history, and in some cases, your cash reserves when deciding which APR to give you.

To get approval for any type of credit product (credit card, loan, mortgage, etc.), you must first submit an application and agree to let the lender withdraw your credit report. This helps lenders understand how much debt you owe, your current monthly payments, and how much additional debt you are able to incur.

For large loans, such as mortgages, you will also need to submit additional documents showing how much money you have in the bank, as well as your income and other assets.

Taking these documents into account, the bank or lender assesses your creditworthiness. If you appear to be at a high risk of default, the lender may reject you outright or simply increase your APR.

Here are some factors that go into determining your APR:

  • Type of credit product: According to the latest Fed report The data, personal loans have an average APR of 9.34% and auto loans are 4.98%. Thirty-year fixed rate mortgages are averaging 2.81% this week, according to Freddie mac.
  • Credit score: A higher score qualifies you for the lowest interest rates.
  • Payment history: More on-time payments make you a competitive candidate for lower rates.
  • Type of interest rate (fixed or variable): Fixed rate loans charge the same APR for the entire term (duration) of the loan. Variable rate loans fluctuate, which means that you could potentially save money but also be charged more if rates go up.
  • Loan term (if applicable): As a general rule, the longer the term of the loan, the higher the interest rate will be (but not always). This is because shorter terms ensure that the lender will get their money back sooner so there is less risk.
  • Deposit (if applicable): You may qualify for a lower rate by making a larger down payment.
  • Benefits and rewards (if applicable): Credit cards with better rewards programs tend to have higher APRs.
  • Location: Mortgages in particular are influenced by state governments and municipalities. Each state can have unique taxes, property laws, grants, and / or regulations that can affect the cost of your mortgage.

How your APR is calculated

The APR is expressed as a percentage of what you pay over a year. If your mortgage APR is 4.5%, for example, you make monthly payments that are about 4.5% of the 12-month average daily balance.

Likewise, you pay interest on your credit card each month that you carry a balance beyond your Grace period. Keep that balance for a year and you’ll end up paying interest charges equal to your APR. If your APR is 22.99% and your revolving credit card balance averages $ 5,000, that’s $ 1,149.50 of interest paid per year (billed over the months you have a balance) until you pay it off.

Interest is a simple concept, but figuring out how it’s billed can be a bit tricky. Learn more about how the APR is calculated here.

Don’t miss: How the prime rate works and how it affects you

How to prepare for an upcoming application

If you know you want to apply for a loan, mortgage, and / or credit card in the near future, prepare now by looking at your credit report. Experiential offers a free credit monitoring service that allows you to view your borrower profile and get an updated Experian credit report every 30 days.

Once you know your credit score, you can get a better idea of ​​the interest rate you might be getting. The closer you are to having prime or super-prime credit, the more likely you are to qualify for the best APRs.

Some experts say that reaching a 760 credit score you’ll get the best deals on everything from mortgages and auto loans to credit card rewards.

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Editorial note: Any opinions, analysis, criticism or recommendations expressed in this article are the sole responsibility of the editorial staff of Select and have not been reviewed, endorsed or otherwise approved by any third party.

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