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Stupid Money: What’s a Good Interest Rate, and Why Are They So Wildly Different?

There are a lot of factors — some of which you can control

Every time you want to borrow money, it comes with an interest rate. This is, of course, the “price” of borrowing that money. But why is the interest rate for a mortgage different for that of an auto loan? Or a credit card? What makes them change, and what’s a good rate for them? We did some digging.

Why do all these loans have different interest rates?

There are lots of reasons, but mainly it’s because each rate is determined by different economic factors. What most have in common, though, is the Federal Reserve rate: This is the base-level cost at which banks can borrow money from each other at any time, so the interest rate for anything will never be lower than this.

After that, several other factors go into setting a rate: The length of the loan (longer-term loans can usually command a higher interest rate); the amount of risk (which is where having a good credit score is important); the projected rate of inflation (so that lenders don’t get screwed by inflation in the future); and liquidity (as in, how easy is it for the lender to resell the loan onto another institution, or at least get the money back?)

So how does that play out in different kinds of loans?

Let’s take mortgage rates, as an example. They can be long-term, but they’re also considered a very safe form of borrowing: That’s because for one thing, you need approval for them (a more thorough process since the recession), which means you’re deemed worthy of loaning the money to. And secondly, if you default, the lender just takes your home, which it can pretty easily sell and get its money back.

With credit cards, interest rates tend to be much higher because there’s really no obligation to pay any interest — if you pay off the balance every month, the creditor gets nothing. But if you don’t, rates can get steep! People pay them, at least until they get buried far enough under them and other debts to declare bankruptcy. In bankruptcy proceedings, the credit card companies usually get stiffed, but then again, they’ve already made money hand over fist from all their other cardholders paying high interest rates.

Auto loans, meanwhile, are usually three to five years, so they’re shorter term. They also require approval, which mitigates the risk a little, hence them being fairly low. And like a home, your lender can repossess your car if you don’t pay for it (though unlike homes, cars almost always decrease in value).

How come the rates for each of these things is constantly changing, though?

It depends on different things, like what the interest rate is tied to, and obviously, the economy. Mortgage-rate changes are tied most closely to the yield on 10-year Treasury notes. That’s partly because most mortgage loans will either be paid off or resold within 10 years, so historically, the movement of the 10-year bond is a good indicator of the movement of mortgage rates. There’s also the economy: When times are good, rates rise to keep borrowing in check; when times are bad, rates fall to encourage investing. But from a macro perspective, when the Fed goes up or down, mortgage rates tend to do the same.

Credit card rates are very closely tied to the federal interest rate. As it moves, so does a bank’s cost of borrowing money, which it then passes onto the credit card holder in its variable rate.

Auto loans play by their own rules a bit, since 80 percent of new-car sales are financed through the auto dealer directly, not a bank. Which is to say that interest rates are less dependent on the Fed and more dependent on a car company’s desire to sell cars at an attractive price. Which is, of course, tied to the economy in a roundabout way (people are inclined to buy more stuff when the economy is good, and less stuff in uncertain times).

Okay, so what’s considered a good interest rate for all this stuff?

That’s a bit tough to say — as we’ve seen above, we’re all somewhat at the mercy of the economy and the federal interest rate, which are influenced by a multitude of factors way beyond most people’s control (unless you believe in the power of the Illuminati, The Trilateral Commission, the Bilderburg Group or just Goldman Sachs).

Apart from that, the size of your down payment on your home or car will affect your rate — the larger the down payment, the better your interest rate. When you see an attractive rate advertised, read the fine print: It often involves a substantial down payment.

Last but never least, here’s where your creditworthiness makes an enormous difference. The best rates go to those with a high credit score: “740-plus is really the magic number to get you the best rates in most every category,” says Frank Kriticos, a consumer-credit expert. He also suggests reading the fine print on the next car commercial you see or attractive mortgage offer you come across. “That’s all 740-plus,” he says.

As far as a “good” rate? For mortgages, check out this Freddie Mac line graph showing rates going as far back as 10 years. A 30-year fixed rate mortgage reached its lowest rate in a decade back in May 2013, at 3.35 percent. Here’s what auto loans looked like over the past two years (pretty stable at a little more than 4 percent). And here’s what credit card interest rates look like since 2010, searchable by type of card (expect it to be in at least the mid-teens).

So what are the takeaways for borrowing money at a good interest rate? As always seems to be the case, the better off you are, the less you’ll actually have to pay. So for the love of God, keep your credit score high, offer a good down payment, and if you can afford to wait a while, keep an eye on the economy for trends.

We hope this held your interest.