Effective debt management strategy allows you to save money on interest expenses and avoid financial distress. As part of your financial plan, it is important that you learn to evaluate finance rates by comparing the same types of loans against each other. To begin, categorize competing loans according to type and structure. Then, monitor economic and personal finance trends that affect your interest rate offers.
Loan Collateral
A secured loan, such as a mortgage, is backed by collateral. Terms of the secured loan grant your lender the right to seize collateral and auction it off if you default on the loan. The loan collateral effectively protects banks against significant losses and allows you to negotiate relatively low interest rates. An unsecured loan agreement, however, relies strictly upon the bank's good faith in you to make payments. A credit card is an example of an unsecured loan.
Fixed Vs. Variable Rates
In terms of interest rate structure, credit agreements may be grouped into fixed and variable-rate loans. A fixed-rate loan charges the same interest rate throughout its term. Alternatively, a variable-rate loan interest rate charges shift each month, according to the prevailing interest rate environment.
As a conservative borrower, you are likely to prefer fixed-rate debt so that you may budget around regular loan payments. Variable-rate loans allow for higher degrees of customization. For example, adjustable rate mortgages (ARMs) are popular with people who have irregular incomes. An ARM may charge low interest rates for an initial two-year period before rates shift each month to add a 5 percent premium to the prime rate.
Economic Trends
Loan interest rates track the strength of the domestic economy and the federal funds rate. Banks loan money to each other overnight at the federal funds rate to meet their Federal Reserve requirements. The federal funds rate serves as a benchmark for all interest rates.
In a recession, you can expect the Federal Reserve Board to lower credit interest rates through its federal funds rate. Lower interest rates stimulate the economy because they encourage people to borrow, spend and invest money. Alternatively, the Fed drives rates higher to shield a growing economy from inflation risks. You can monitor and compare the federal funds rate against other benchmark interest rates by following them in the daily Wall Street Journal.
Personal Finances
A bank will evaluate your personal finances before setting interest rates. To negotiate the best interest rates, you should work to keep expensive credit card debt to a minimum, while also maintaining at least six months of living expenses in cash reserves. Your credit report is especially important, because it organizes your debt history according to payments and loan type. You may order a copy of your credit report through Equifax, Experian, or TransUnion.
As a consumer, you should comparison-shop among at least three different banks for the same type of loan. To save money, do business with the bank that offers the lowest interest rate.
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