Understanding Interest Rates Most
interest starts off at a base number based on the current base rate set by the
Bank of England, usually somewhere between 3% and 7% (September 2008 it is 5%).
From there, the additional interest is adjusted based on your risk.
Now, the amounts may seem minimal. For example, a 20 point gain in your credit
score only nets you a reduction of approximately a .125% drop in your interest rate . If you are borrowing very little (a
couple of thousand pounds) the difference is only going to be 20 or 30 pounds
over the course of a loan. Considering many loans can last as long as 10 years,
that difference is minimal.
However, when you are borrowing a lot, in the range of 10's
of thousands of pounds, every little bit your interest rate drops represents
a dramatic difference in your total interest paid. That is why when you are
riskier, the loan may raise your interest by what seems like an
inconsequential amount (.5% or 1%) but the difference can be thousands of
pounds over the course of the loan. Each bank has its own
calculation of a risk profile, and the base rate can change depending on the
economy. But if the base rate is 4%5%, then if you have no risk than you
will get somewhere between 6% and 6.125% (it is rarely ever the base rate).
If you are very little risk (say a credit
score in the early 700's) then your interest rate should be
between 6.375% and 6.75%. And if you represent a great deal of risk (650 and
under) then your interest rate will go from 7% to as much as 9%, though
usually no more than 8.5%. Base rates are often higher depending
on the loan, but the increments tend to be around the same amount.
Variable Rates Some rates are what is known as
"Variable." Variable rates move with the economy. So, for example,
if you are paying 2% over the base rate on your loan due to your risk
factor, and the base rate of the loan moves up and down because the economy
has changed, then your variable rate can move with it, keeping you at 2%
over whatever the base rate is.
The opposite of this is a fixed rate, meaning that if
you sign on for an interest rate of 6.5%, your interest rate will never
change, regardless of whether or not the base rate changes. When
you refinance, it is recommended that you use a fixed rate. Even though it
is possible for the base rate to go down, it is much better to know that
when you have refinanced your other loans, whatever interest rate you are
paying is going to be a set rate, and one that you have calculated to be
affordable.
