How do banks calculate the interest rate?

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As many banks exist, interest rates on loans are also different. Why is that so? 

Even if the calculation of the interest rate seems complicated at first glance, the principles are simple.

Lending rates: There is something to be aware of

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One of the most important terms related to loans is the interest rate. This value affects the cost of borrowed capital immensely. As a rule of thumb, the lower it is, the cheaper the credit.

Different financial institutions offer consumers very different interest rates. With the right offer you can save a lot. But it is worth taking a look at the fine print: Banks often use the borrowing rate to advertise. But you should always pay attention to the effective interest rate, also known as annual percentage rate . Because only with the latter are all costs and fees already included.

Credit-Related Loans: What Banks Consider

Credit-Related Loans: What Banks Consider

However, the interest rate is not always given as an absolute number, but as an interest margin. The actual value of credit-based loans is calculated from many individual factors. For example, the regular income of the borrower is taken into account. The individual expenses, the assets and the place of residence are also significant.

Other variables that are considered are: the employer, the position and position in the company and the type of employment. For example, having a part-time contract or self-employment makes it harder to get a loan. A Schufa entry also has a negative effect. Why are these factors taken into account? The bank calculates the default risk. A high earner probably pays back the loan rather than someone with less financial resources. The higher the probability that someone can pay, the greater the creditworthiness – and the better the interest rate.

You can have a positive influence on the factors of the credit-based loan: Lowering your loan amount, for example, also reduces the risk of default. At the same time, your monthly payments and thus your individual expenses will drop.

Term, purpose and loan amount: Three important factors

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The term also affects the loan interest. If the borrowed amount is paid off quickly, interest rates will fall. At the same time the risk falls for the bank and some of the surcharges and fees remain off. It is therefore advantageous if you pay a installment loan quickly, for example. The monthly rate should fit into your budget. In addition, the term together with the loan amount plays a role in the calculation of the loan interest. Because both require each other.

The purpose is also relevant for financial institutions. A loan with a concrete benefit usually has good interest rates. In a car loan , the mobile subset serves as security. For a construction loan, the house and property are pledged.