Whether you’re looking to buy a car or finance a vacation home, your interest rate will help determine how much you pay per month on your purchase. Along with the purchase price and loan term, your interest rate is an important driver in your monthly payment and what you end up paying in total for the item. High-interest rates mean higher monthly payments and potentially thousands of extra dollars in interest costs. Low-interest rates allow you to borrow money at a lower rate, ensuring a lower monthly payment and lower costs over the life of the loan.
While everyone wants a good interest rate, not everyone will qualify for one. Here are three ways you can lock in the best interest rate possible on your next loan.
Keep Your Credit in Check
Depending on your loan, interest rates are maintained by The Federal Reserve, market forces, or some combination of the two. When the economy is doing well, interest rates typically rise. When the economy is doing poorly, such as during a recession, rates tend to fall. These factors are all out of your control, but your credit score is a huge factor in determining the interest rate that you can control.
Depending on the particular credit score model used by the lender, your credit score should be at least 740 or 781 to be considered a very good credit score. A higher score will help you qualify for an improved interest rate. If it’s not quite there yet, you can improve your score by paying all of your bills on time, disputing any errors on your report, keeping your balances low on all credit cards, and working to pay off all of your debts. It can take months, if not years, to rebuild your credit (or establish credit for the first time).
Give yourself enough time in advance to improve your score before applying for a loan. Get your credit reports several months ahead of time (it’s free), and if time runs short ask about rapid rescoring.
The chart below shows how credit scores impact the amount of interest you pay when you take out a loan.
What one lender offers you could vary significantly from what another lender does. Credit unions, for example, can typically offer lower rates than large, national banks. Also, if you’ve been banking at the same place for a while, get a quote from that institution first. Sometimes banks offer lower rates to long-term customers as a way to say ‘thank you’ for doing business with them and to keep good customers from looking elsewhere.
Shopping around for loans can negatively affect your credit score because each time you apply for a loan, your credit takes a hit. To minimize the damage, do all of your shopping within a short period of time. Mortgage companies and auto loan lenders know that customers are going to want a few different quotes—that’s what savvy borrowers do. As a result, credit scoring models look at windows of time in which you shop; as long as you’re applying for a home loan or auto loan, your credit will only be hit once during that period no matter how many inquiries you get.
How much time do you have to shop around without racking up inquiries? It depends on the credit scoring model, but you can count on at least two weeks, and you might even have up to 45 days (especially for home loans).
Note: This only applies to home and auto loans. Credit card applications and other loans will affect your credit score every time you apply.
Get the Right Term
When getting a loan, typically longer-term loans will have lower interest rates than shorter ones. Keep in mind, though, that a longer loan term means it’s going to take you longer to pay off the loan. In the end, you might pay more money in interest than if you took on a shorter loan with a higher interest rate.
The reverse is typically true on accounts where you might make money—such as a certificate of deposit (CD). When 1-year CD rates are at 1.20% APY, you might see 5-year CD rates at 2.25% APY. If you can afford to tie your money up for longer, you’ll make more money on longer-term CDs.
It’s always best to pay off debt as soon as possible, so if you can afford a higher monthly payment, go with the shorter loan term. Want to see the numbers for yourself? Try some what-if scenarios on our loan calculator.
By keeping your credit score in check, shopping around, and getting the right term for your loan, you’re setting yourself up for the best interest rate possible on your next loan.