What Is the Meaning of Lending Rate?

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What Is the Meaning of Lending Rate?
What Is the Meaning of Lending Rate? (Image: andrew taber)

The lending rate is the charge that a lender charges a borrower in order to make a loan. The term "lending rate" is synonymous with the the term "interest rate." Though this rate can be a very important factor in determining what the final cost of the loan will be, there are others that should not be ignored. Many different things can also affect lending rates. Therefore, those who are borrowing money should make sure they understand what some of these factors are.

Function

The function of interest rates is to entice those with the money to lend it to other individuals or organizations. If there is no financial benefit to the bank or lending institution to lend the money out, then there is no reason to lend the money. This could, ultimately, be very harmful to the economy and cause hardships for the borrower.

Types

All lending rates apply to loans, but there are different types of loans that may influence what those rates are. Secured loans, such as those for mortgages or vehicles, are the safest for the lender and come with lower rates. Credit cards and other unsecured loans represent the most risk and therefore are charged at higher rates.

Significance

While lending rates are necessary, there are ways to make the rates more affordable for the buyer. Rates are tied to the Federal Reserve fed funds rate. Therefore, when this rate is lower, the borrower gets a better deal. An individual's credit score can also affect interest rates. The difference in lending rates between those with good credit ratings and poor credit ratings can be greater than 1.5 percent on a secured loan. It can be much higher, greater than 10 percent, on an unsecured loan. For current rates, see Resources below.

Other Costs

Lending rates represent much of the cost associated with a loan, but they are often not the sole factor. There may be closing costs or processing costs associated with a mortgage or car loan. For a credit card, there may be an annual fee. These fees are often overlooked as insignificant, but they are added expenses that should be taken into account.

Effects

The interest rate will have a great deal of influence on the total principle paid. For example, a $300,000 loan over 30 years with no interest would require payments of slightly more than $833 per month. At an interest rate of 4.99 percent, that amount goes to more than $1,600 per month. At an interest rate of 6 percent, the payment is more than $1,800.

Warning

Always understand what lending rate is being used in your situation, especially with mortgages. A fixed-interest rate will provide the same rate for the loan throughout its life. A variable rate could change, depending on the economic situation and what the Federal Reserve has its rate set at. This could add significantly to the cost of the loan over the years.

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