In this article:
You can think of interest as the cost to borrow money. The lower the interest rate you're able to qualify for, the more money you'll save over time when you borrow. That's why it pays to know what goes into determining an interest rate.
Lenders consider your credit score, income, payment history and broader economic benchmarks such as the prime rate when determining an interest rate on a loan, credit card or line of credit.
Read on to find out what factors have the biggest influence on interest calculations for various types of credit, such as credit cards, mortgages and other types of loans—plus how you can qualify for the best interest rates.
How Lenders Determine Credit Card APRs
Credit card issuers set your interest rate based on your creditworthiness, among other factors. Here's what goes into determining your credit card's annual percentage rate (APR).
1. Your Credit Report and Scores
Your credit score is typically the most impactful factor in determining what credit cards you'll qualify for—and what interest rates lenders are likely to offer you. Credit card issuers usually offer the lowest interest rates to borrowers with high credit scores. A lower credit score can be an indicator of a risky borrower, so lenders often charge higher interest rates in this case to offset the risk.
FICO Scores, the scores used by 90% of top lenders, range from 300 to 850. A FICO® Score☉ of 670 and up is generally considered to be good. Here's a breakdown of the score ranges and how they factor into how lenders might view your creditworthiness:
| FICO® Score Ranges | |
|---|---|
| Less than 580 | Poor |
| 580 to 669 | Fair |
| 670 to 739 | Good |
| 740 to 799 | Very Good |
| 800 and up | Exceptional |
The higher your score, the better. Here's what goes into calculating your FICO® Score, in order of impact:
- Payment history (35%)
- Amounts owed (30%)
- Length of credit history (15%)
- Credit mix (10%)
- New credit (10%)
2. The Type of Credit Card
Depending on the specific issuer or type of card, some credit cards may carry higher interest rates than others. For instance, some rewards cards come with steep interest rates, which means they're generally only worth their benefits if you don't plan to carry a balance from month to month.
How Lenders Determine Personal Loan Interest Rates
Here's what goes into determining your interest rate for a personal loan:
1. Your Credit Report and Scores
Much as is the case with credit cards, lenders set personal loan interest rates based in large part on your creditworthiness, and they'll use your credit report and score to get this information. Your credit score can determine whether you'll qualify for a personal loan at all, as well as what APR you'll pay if you qualify.
2. Your Employment History and Income
Lenders look at your income and employment history for an indication of how reliable your income is and how likely you are to repay your loan. Applicants who have been in the same job for multiple years or who have a higher income may look more financially stable than someone who changes jobs often or has a lower income.
3. Your Other Debts
Lenders look at a metric called your debt-to-income ratio to determine how much of a burden taking on a new loan will be for you, and they determine your eligibility and set your interest rate accordingly.
4. Loan Size and Term
The size of the personal loan and the length of the loan term you're applying for play into the interest you'll pay. The term of your loan is how much time you have to repay it. A shorter loan term typically comes with a lower interest rate—plus larger monthly payments, which means paying even less in interest over time.
How Lenders Determine Mortgage Interest Rates
For most people, a mortgage is the largest loan they will ever get—and that's why it's crucial to get the best rate possible. Even saving a fraction of a percent on your rate can save you thousands of dollars over the lifetime of the loan.
Here's what lenders consider to determine your mortgage interest rate:
1. Your Credit Report and Scores
Most lenders look at credit scores when deciding whether you qualify for a loan, and mortgages are no exception. That's why it's important to review your scores and credit reports regularly to make sure you're doing everything you can to keep them as high as possible.
2. Your Down Payment
In some cases, the bigger the down payment you make, the lower the interest rate you'll qualify for. That's because mortgage lenders see you as less risky if you make a substantial down payment. Ideally, you'll put down 20% or more for the best rates.
3. Your Loan Term and Size
If you can get a loan for a shorter period of time, you may be able to qualify for a lower interest rate. With a shorter-term loan, you'll likely have a higher monthly payment but lower costs overall. The same goes for the size of the loan: If your loan is particularly large or small, you might be able to qualify for a lower interest rate.
4. Your Loan Type
Mortgage loans come in different categories: conventional, FHA, USDA, VA loans and more. The rates on these different types of loan products can vary significantly, which is why you should shop around and do your research on what you might qualify for.
5. Your Location
Where you're buying a property also factors into the interest rate. Simply put, some markets are more expensive than others.
How Lenders Determine Auto Loan Rates
Auto loan lenders use the following factors to determine your interest rate:
1. Your Credit Report Scores
Your credit history plays a big factor in auto loans as well.The higher your credit scores, the lower your interest rates on car loans. Those with low credit scores will typically be charged more interest, and can benefit by improving their score before they apply for a car loan.
2. Your Down Payment
Just like with mortgages, the more money you put down when buying a car, the more likely you are to qualify for a lower interest rate—because there's less risk to the lender.
3. Your Loan Term
Again, the shorter your loan period, the lower the interest rates you'll have access to.
4. Your Car
The age of your car also plays a big role. New cars generally come with lower interest rates, while older cars carry higher rates because they hold a lower resale value.
How to Qualify for the Best Interest Rates
Having a low credit score won't make borrowing impossible, but it can limit your options and mean paying more in interest. Here are steps to qualifying for the best interest rates:
- Improve your credit. Low personal loan rates typically go to people with high credit scores, so taking steps to improve your score now is key. As you work on improving your credit over time, aim for a goal of good to excellent credit to qualify for the best rates.
- Keep your requirements in mind. If you can afford higher monthly payments, opting for a loan with a shorter repayment term can help you pay a lower interest rate now, and make a huge difference in what you pay over the life of the loan.
- Compare offers. Compare personal loan interest rates before you apply to ensure you're opting for the best deal you can get based on your credit profile, income and debts.
The Bottom Line
Regardless of what type of credit you need, your first course of action should be ensuring that your credit reports and scores are in tiptop shape.
Check your credit score for free through Experian and sign up for free credit monitoring to keep an eye on your progress. You'll get information about your score, alongside explanations on what's impacting your score and personalized tips on how to improve your creditworthiness.