Lenders have to be highly considerate when setting up a loan’s interest rate to ensure that the product will be affordable to consumers. However, they also have to factor in their own needs by minimizing the risks involved. Generally, the applicable rate determines the total cost that a consumer will incur on a certain loan product and the margin to be enjoyed by the loan provider for the lending services.
The external factors that influence interest rates include:
- Monetary policy
Lending activities in banking sector are centrally regulated and there’s a monetary policy that stipulates the base lending rate to be adhered to by lenders. This helps to enhance stability and ensure that applicants are protected from possible exploitation by loan providers. The policy also helps to control money supply and this causes fluctuations on applicable interest rates based on the cash in circulation.
Inflation contributes to higher prices of commodities and this then affects the spending habits of consumers. This is a situation where they are left to make fewer purchases with the same currency unit. In order to protect their returns during inflation, lenders are forced to make adjustments on their interest rates and there are cases where they can even tighten their loan policies.
- Economic uncertainty
In a stable environment, lenders can comfortably apply flexible lending standards since there are usually high hopes of receiving prompt payments on their loans. However, the situation changes where there’s uncertainty on the future state of economy and lenders tend to take some conservative measures. They can then choose to adjust the applicable rates upwards or limit the financing available to applicants.
If the status of economy is favorable, people tend to spend more with an aim of getting increased returns. This in turn puts pressure on money supply and the situation can contribute to higher interest rates if the increased demand is not sustained. The same scenario is also likely to play out where the exchange rate is not working in favor of the local economy. This pushes the locals to spend more on imports and earn less from exports.
- Government borrowings
The government can decide to borrow locally to supplement its budget and lenders would rather lend to the government compared to individual borrowers since they will be guaranteed of payments. This leads to a reduction in the cash available for lending and creates huge demand for the funds. Consumers are then left to borrow at higher rates.
Apart from these external factors, there are also other considerations that lenders make before approving applications by consumers. These usually relate to the person submitting an application and they include:
- Credit scoring
Credit scoring is based on the reporting made to credit bureaus and individuals with impressive scores are considered for financing at better interest rates. This also comes with additional benefits like accessing huge financing and qualifying for flexible payment plans. There are various factors that are considered when determining credit scoring including payment history, credit period, existing debts and credit limit.
The lenders analyze a person’s monthly income to establish whether a given loan product is affordable or not. Without a stable income, you will be valued as a high risk applicant and the interest rate allowed will be pretty high. However, you can negotiate for a better offer by providing security or finding a creditworthy person to act as your cosigner.
The current lending sector is providing people with numerous options on financing and the competition is pushing lenders to introduce flexible loan products. This is allowing consumers to enjoy reduced costs of borrowing.