While the credit crunch clearly dampened consumers’ borrowing power, the lending well hasn’t run completely dry. Lenders still want to lend, but borrowers will need to dig deeper to get the best rates.
The Federal Reserve probably plays the most visible role in influencing rates, as it orchestrates money supply. Contrary to popular belief, though, when the Fed trims rates, the effects don’t necessarily trickle down to every credit and loan product.
Knowing what influences interest rates may help you negotiate a better deal the next time you need to borrow money.
Learn how to get the best rates on:
- Home equity loans and lines of credit.
- Credit cards.
- Auto loans
- Student loans
- Personal loans.
1. The skinny on best mortgage rates
What impacts rates: Fixed-rate mortgages are influenced by the current economy and investor expectations.
“Fixed-rate mortgages are pegged to long-term interest rates, like the 10-year Treasury note, and are not connected to short-term interest rates controlled by the Fed,” says Greg McBride, Bankrate’s chief financial analyst.
Short-term rates do affect adjustable-rate mortgages, or ARMs, because the indexes to which they are pegged are shorter term in nature, says McBride.
“Adjustable-rate mortgages are often pegged to the 1-year Treasury or a short-term Libor index, either of which is more closely correlated with the short-term interest rates under the Fed’s control,” he says.
For information on the latest mortgage rates, see Bankrate’s mortgage survey.
How to get the best rate: You’ll need proof of stable income, preferably a tenure of 2 or more years at the same employer, a FICO score of at least 740 and a verifiable down payment — plus cash reserves, says Ritch Workman, former president of the Florida Association of Mortgage Brokers.
“That’s our poster-child borrower,” he says. “They’re the ones being offered the best rates.”
Zero-down-payment loans have gone the way of the horse and buggy, so expect to cough up more money at closing to qualify for the best rates — especially if you’re near the conforming loan limit for your area. (Conforming loan limits vary according to area but are predominately $417,000. A conforming mortgage is one that is eligible for purchase or securitization by government-sponsored enterprises such as Fannie Mae and Freddie Mac.)
“It pays to strategize to either make a larger down payment or borrow less money so you can get that mortgage under that conforming loan limit and at a lower rate,” McBride says.
Another rate-reducing strategy is to pay discount points or an origination fee upfront. Both fees are expressed as a percentage of the loan amount, and both will decrease the interest rate of a mortgage, but will increase the amount of cash you need at closing.
On a $200,000 loan, a 1% origination fee (also called a loan-processing fee) will mean $2,000 out of pocket at closing.
Origination fees may or may not be negotiable. Some lenders won’t write a loan without an origination fee, says Workman.
How much do discount points lower your mortgage rate? It depends on what’s going on in the mortgage market, but 1 point usually lowers the interest rate by one-eighth to three-eighths of a percentage point. General rule of thumb: 1 discount point equals a quarter-point rate reduction.
Paying points generally means reduced monthly payments and interest over the life of the loan, but you’ll need to consider how long you plan to stay in the home to see if the trade-off is worthwhile.
“If it takes more than 24 to 36 months to pay off the point, it’s typically not worth it financially because most Americans sell or refinance their home within 5 years,” Workman says.
2. The skinny on home equity
What impacts rates: Home equity loans are pegged to long-term interest rates like the 10-year Treasury notes, while home equity lines of credit, or HELOCs, have variable interest rates pegged to the prime rate. The prime rate moves in lock step with Fed interest rate changes.
With home equity loans, borrowers get money upfront in a lump sum at a fixed interest rate and make the same payment each month for the loan term.
HELOCs are lines of credit that allow the borrower to draw money periodically when needed. The interest rate can vary, depending on the prime rate, and the borrower may have the option to make interest-only payments over specific periods of time.
How to get the best rate: Know your credit profile and take action while interest rates are low.
To get the best rate, it pays to comparison shop. Compare home equity loan rates and HELOC rates offered in your area on Bankrate.com.
3. The skinny on best credit cards
What impacts rates: Variable-rate credit cards are pegged to the prime rate and rise and fall with movements of the Federal Reserve.
Fixed-rate cards are a bit of a misnomer because the interest rate is not really fixed. Rates can change at the card issuer’s discretion with as little as a 45-day notice.
However, credit card companies are quicker to react when rates are rising.
“Cardholders are more likely to see fixed rates increase when interest rates rise than they are to see fixed rates decrease when interest rates are falling,” says McBride.
Interest rates on gold and platinum cards are often lower, and have higher credit limits and annual fees.
They may come with added perks such as rental car insurance, travel points and cash-back rewards, but consumers generally need higher credit scores to qualify for them.
How to get the best rate: Card issuers have raised the bar when it comes to who gets the best rates.
To get the best rates, you may have to check your credit report for any blemishes it might have. You can order a free copy of your report from each of the 3 major credit reporting agencies once every 12 months.
Consumer sites that compare credit card offers can also save you money in the long run.
Bankrate provides credit card information based on individual issuers, card type and credit type.
4. The skinny on auto loan rates
What impacts rates: Interest rates on auto loans can be pegged to either the prime rate or yields on Treasury securities.
Lenders use risk-based pricing. So, as is the case with other lending products, customers with the highest credit scores will qualify for the lowest interest rates.
How to get the best rate: Get a copy of your credit report and correct any inaccurate information. Check car-buying guides and websites and get a price range for the vehicle you’re interested in before you step foot on the dealer’s lot. Compare finance offers from various lenders, not just the manufacturer’s finance arm at the dealership.
Before going to the dealership to shop for a new car, get your free credit score at myBankrate.
Some auto manufacturers are offering low-interest or 0% interest financing on select models to qualified customers.
You’ll need excellent credit to qualify for these deals and may need to pay off the loan in as little as 36 months.
If you have bad credit, you’re going to run into 2 possible scenarios. “Some lenders just won’t give you credit at all, and those that do are going to charge you a higher interest rate,” McBride says.
For those with less-than-stellar credit, there is another option to consider: credit unions. For the most part, these financial institutions use the same risk-based analysis that other lenders use, i.e., FICO scores, but with any additional extenuating information that might factor into the lender’s decision.
5. The skinny on student loans
What impacts rates: The federal government sets the interest rates on federal student loans such as the Stafford and Plus loans.
The College Cost Reduction and Access Act, signed into law in September 2007, changed the interest rates on subsidized Stafford Loans from 6.8% to 6%, starting with loans disbursed on or after July 1, 2008. The rate then moved down to 5.6%, where it remains.
Private student loan interest rates are variable and based on either the Libor index or the prime rate.
“In our case, they are based on Libor and can change each month based on the way the Libor moves,” says Patricia Nash Christel, vice president of corporate communications at Navient.
How to get the best rate: Federally backed, subsidized student loans are available at attractive fixed interest rates to any qualified college student based on need and regardless of credit score.
Prospective students should fill out a Free Application for Federal Student Aid, or FAFSA. The filing season begins in January, and it’s in your best interests to file as early as possible. Early filers often qualify for the maximum amount of grants and low interest loans, according to Christel.
If you need a private loan and your credit is iffy, get a copy of your credit report before applying for a loan to make sure there are no surprises. Then get several quotes as quickly as possible.
“To the extent that you are shopping around for private loans, we advise that you shop within a short period of time,” says Martha Holler, a SallieMae spokeswoman.
It’s best to shop loans within a 10-day period so that the credit bureaus don’t assume you are looking for multiple loans and adversely lower your credit score because there are too many inquiries, she says.
If you’re seeking help from parents, see if Mom and Dad might be willing to apply for a Plus loan, which offers fixed rates.
6. The skinny on personal loans
What impacts rates: Interest rates for personal loans are comparable to interest rates for credit cards, which are loosely pegged to the prime rate.
“In many cases they’re sort of substitutes for each other,” says McBride. “That’s another product that really doesn’t move around a whole lot. It’s a higher-risk product, and it’s not as sensitive to interest rate changes.”
Financial institutions will also base personal loan rates on other factors unrelated to such indexes as the prime rate.
How to get the best rate: Shop several lenders.
Credit unions are a viable alternative to traditional lenders. They generally offer favorable rates on loans and credit cards to their members. (Customers are actually dividend-eligible shareholders and are referred to as members rather than account holders.)
They tend to look at a member’s overall financial situation and relationship with the credit union rather than the FICO score alone.
You may also be able to secure a lower interest rate for a personal loan from a traditional lender by using collateral, such as home equity or a free-and-clear car title, according to McBride.