Interest Rate Calculator
This calculator can be used to figure out the real interest rate of a loan with fixed term and fixed monthly payment. For example, the auto dealer may only give you the monthly payment amount and the total price. This calculator can help to figure out the actual interest rate in such situation.
If you are looking for calculator to calculate the interest of an investment, please use our interest calculator. If you are looking to understand the different of different interest, please use our compound interest calculator.
Who Sets Interest Rates?
In most countries, interest rates are determined by the central bank ‐ in the U.S., this is the Federal Reserve.
The purpose of the central bank's fixing monetary policy ‐ that is, the amount of money in supply, and the amount of interest rates banks charge on it, is to ensure the stability of prices. If there is too much money in the supply, prices can go up too rapidly ‐ that means spiraling inflation. If there is too little money, prices may drop.
This is why the central bank fixes interest rates ‐ as a control on price movements. High interest rates make borrowing money more expensive, so the economy slows down and prices fall. High interest rates also make it attractive to deposit money in banks, and so the supply of money decreases. Low interest rates make it easy to get credit, and this may stimulate economic growth.
The central bank lends money to commercial banks at the rate the board believes will keep prices from moving too much in one direction or the other.
In the U.S. interest rates are determined by the Federal Open Market Committee, which consists of the seven governors of the Federal Reserve Board and five Federal Reserve Bank presidents. The FOMC meets eight times a year to determine the near-term direction of monetary policy and interest rates.
How Do Banks Decide Interest Rates?
Commercial banks base their interest rates on those of the central bank, and they add to them a margin of profit for themselves. While banks may charge whatever interest rates they choose, banks competing for business pay attention to the market for loans.
The Federal Reserve sets different interest rates for use in different contexts. The Federal funds rate is one key rate, because banks use it to borrow the money from the Fed. The prime rate is a rate that banks use for the ideal customer with a solid credit rating and payment history. Other considerations that banks may take into account are expectations for inflation levels, the trends on the loan market throughout the country, stock market trading levels ‐ all critical aspects of economic life.
Different types of loans base their interest rates on a specific indicator. Mortgages, for example, take their base rate from the interest charged on Treasury bills, government securities that the Treasury auctions off to obtain revenue.
Banks determine how much to charge based on four basic factors. First, the bank considers the cost incurred by the bank to raise funds to lend, whether such funds are obtained through customer deposits or through other channels.
Then the bank takes into account the costs of processing the loan, which include application and payment processing, and a percentage of all of the bank's operating expenses.
The bank also calculates a profit margin on each loan that provides the bank with an adequate return on its capital.
Then the bank adds on a risk premium to cover bank for the risk it is taking ‐ each loan adds a certain level of risk so the bank must see that there is a margin for risks that don't work out.
Getting the Best Interest Rate
Obviously, the best way to get a low borrowing interest rate is to have a good credit rating. But there are other things that can help you: Putting up collateral for a loan or a large down payment for example. You can also reduce a loan rate by using many services (checking, savings, brokerage, and mortgages) from the same bank to get a discount. Also, borrowing when the economy is slow, and demand for loans is low, can give you a better negotiating position.
One sure tactic in getting a better rate is to shop around, trying to get the best deal among a number of banks. You can even tell one bank that another is giving you a better rate, and negotiate. Get the best rate you can, but be careful about conditions and costs involved.