all about interest

Let’s start with interest. Interest is charged as a percentage of money you’d borrow from a lender. You pay interest on each monthly payment until your loan is paid off.

For example, when you want to buy a car. You likely won’t have the cash to pay for it all at once, so you may borrow the money by taking out a loan. The lender will charge you interest on that loan.

Interest rates are set by individual lenders with influence from the Federal Reserve.1 Yours may be fixed, meaning it won’t change over time, or floating, meaning it may move higher or lower over time.

Market interest rates vary based on several factors, including the type of lender, type of loan and market trends. Your personal interest rate is based on several factors as well, like loan amount, the reason for the loan and most importantly, your credit history. The better your credit, the lower your interest rate, monthly payments and overall cost may be.

How is interest calculated? There are several ways, and it can get complicated, so let’s just talk about the simple interest method2, which is generally used for short-term loans.

You’ll need your principal loan amount, interest rate and the number of months or years you’ll be paying the loan off.

For the example below, we’ll say the loan amount is $10,000, the interest rate is 5% and the number of years is 5. Interest is calculated with this formula: principal loan amount x interest rate x number of years = interest.

Example:
$10,000 x .05 x 5 = $2,500 in interest over the life of the loan

Some banks and lenders use more complicated methods than this, so when looking for a loan, shop around to figure out the best option for you. This is helpful for types of loans as well as interest rates.

You’ll want the lowest interest rate possible. As we said before, good credit is helpful, but it may be possible to negotiate a lower rate. It never hurts to ask.

For lines of credit, you may be able to avoid interest charges if you’re able to pay off your entire balance in full every month.

how do I check my credit report?

Checking your credit report can be easier (and cheaper) than checking your credit score. That’s because you’re entitled to one free credit report a year from each of the three credit bureaus: Equifax, Experian and TransUnion.

If you’re ready to get your free credit reports, check out the link after the quiz.

what’s the difference between my FICO® Score and other credit scores?

The FICO® Score is a three-digit number based on the info in your credit reports and shows how likely you are to repay debt.

Here are the 5 credit-account categories used to calculate it and how they count toward your score: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%).¹

Other companies later created their own scores. The biggest difference may be the percentages or formulas used to calculate your score, although most will use the same categories.

why does my credit score change so often?

Your credit score changes because the info used to calculate it (your credit reports) is always changing. Since your credit history can change from month to month, so can your credit score.

That means every on-time or late payment reported can affect your score. So can getting a new credit account or closing one, when account balances change, or if positive or negative info drops off your credit reports.

how is my credit score determined?

Your score is based on the info in your credit report:

1. credit accounts
   This section shows your open, paid off and closed credit cards, accounts and loans. It also shows how long you’ve had accounts, plus credit limits or loan amounts.
2. credit inquiries
   This shows who has checked your report and it may or may not affect your credit score.
3. public records
   Judgments and bankruptcies are here. Chapter 13 bankruptcies will be on your credit report for 7 years; Chapter 7 will be on for 10 years.

will credit inquiries hurt my credit score?

Credit inquiries are when someone looks at your credit report. There are two types:

hard: These show up when you apply for credit and give the bank or credit company permission to check your credit.

soft: These can be prescreening companies who may want to offer you credit. If you request your credit reports, that’ll show up too. Don’t worry though, soft inquiries don’t negatively affect your credit. That’s great news because everyone should check their own credit reports at least once a year.

how are my credit limits determined?

They’re based on factors like your credit history, credit score, income and credit utilization rate (CUR).

Your credit utilization rate (CUR) is how much you owe, or the total of all your revolving credit accounts, divided by your total credit limits.

how do I lower my credit utilization rate?

The simple answer? Pay down the balances on your revolving credit accounts. When you do that, your CUR will also go down and that can have a positive effect on your credit score.