Debt financing refers to the process of borrowing money upfront from a lender with the intent of repaying the funds back, along with interest, over a specified period of time. Whether you are financing your first home purchase, paying off student loans or consolidating high-interest accounts, it is helpful to understand the interest rate you are paying when financing debt. This information allows you to compare loan products offered at competing financial institutions to find the best deal. Understanding how much you will end up paying in interest also enables you to ensure the debt financing option you’ve selected fits within your budget.
New Debt Financing
Determine the amount of debt you need to finance and compare products offered by competing lenders to find the best deal. Debt can be financed through installment payment arrangements on a short- or long-term basis or through a revolving line of credit. Factors such as the dollar amount of the debt and the length of time needed for the repayment will help determine which finance option best suits your needs.
Speak with a loan officer to discuss the details of each of the debt financing products you are interested in. Complete a credit application once you have decided on a financing product and lender. The term and interest rate the lender is able to offer will depend on factors such as your FICO credit score, salary and employment stability.
Review the details of the debt financing offer once presented by the lender to determine specifics such as monthly payment amounts and the length of the loan term to determine if these are compatible with your budget.
Accept or reject the offer. If the monthly payments are higher than what you can afford, you may want to shop around for a lender that can offer a lower interest rate.
Review your monthly account statement to determine the interest rate you are paying on your current account and whether this rate is fixed or variable. Fixed rates will remain constant while variable rates will fluctuate based on the prime rate. The prime rate is set by individual banks based on the federal funds rate established by the Federal Reserve and is used as a benchmark in setting standardized floor rates on financing products. Applicants with excellent credit will receive rates closer to the prime rate, whereas applicants with average or below average credit will pay a higher rate of interest. The current prime rate can be viewed in the Wall Street Journal and other financial newspapers and websites.
Contact your lender if you are unable to find the interest rate on your statement or if you have questions regarding the way the interest charges are calculated. Interest may be simple or compound, or different transactions may be associated with different rates of interest. Simple interest means that interest is paid only on the original principal amount while compound interest means that interest is paid on the original principal amount plus any accrued interest. For example, a cash advance may have a higher interest rate than a standard purchase. Or a loan with monthly compounded interest will have higher monthly payments than a loan with simple interest.
Lower your interest rate by contacting your lender and asking for a rate reduction or by searching for a lower interest loan from another financial institution. If you need a starting point, sites such as bankrate.com and lendingtree.com offer an easy way to compare interest rates and offers from competing lenders.
- When comparing rates at multiple lenders, make sure you are looking at the annual percentage rate and not the periodic interest rate. The APR includes all fees plus the compound interest rate for the entire year and is often higher than the periodic interest rate, which calculates only the interest on either a daily or monthly basis.
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- Federal Reserve: What is the prime rate, and does the Federal Reserve set the prime rate?
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