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Health & Fitness

How Banks Set Interest Rates

Interest rates are a complicated conversation to have, but it basically boils to two sides of the same coin.

If you are the one receiving the interest payment, you want the rate to be high.

If you are paying the interest, you would like to the rate to be low.

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Interest rates have gotten a lot of “play” in the media over the last few years, and an hour does not pass without a financial markets expert, or even “regular” media, mentioning the yield on the 10-year Treasury bond. Especially with the federal government grid-locked and the debt ceiling looming, interest rates, debt, and the impact they can have on the economy, are front and center right now.

But, how do banks set the rates that we (you and I) pay when we borrow money?

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There is an old phrase that describes what traditional banks do: 3-6-3. Borrow at 3%, lend it out at 6%, and be hitting golf balls by 3 p.m. While amusing, this describes the basic model of traditional banking. The bank lends funds at rates that allow it to generate a profitable return. While every bank is different, and every loan that is issued by that bank will be different, there are a few common factors that you can focus on/improve that might help you to negotiate a lower rate. These are not overnight solutions, but can be very effective over time.

1) Try to improve your credit score as much as possible
2) If you can, put down a large down payment
3) If you do a lot of business with the bank, (savings, checking, brokerage) that might help
4) Copy Warren Buffet – buy when others are fearful. In this case, that might mean that borrowing when the market is less certain might benefit you.

As always, be sure to consult a financial services professional who is familiar with both your personal financial situation and the loan you are considering.

I have attached an excellent article from Investopedia.com that explains all of this in more detail.

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