The loan is not free and the interest serves as a price tag for the loan. All in all, the interest rate of a loan depends on the details of the loan, the borrower, the loan provider and the general financial situation.
Reference rate + margin = loan interest
As the title suggests, the interest rate on the loan consists of a reference rate plus a margin.
The reference rate is a public interest rate that is the same for everyone and can be set by a bank or other lender. In practice, however, the reference rate is either
- market rate (1, 3, 6 and 12 month ) or
- the bank’s own prime rate.
In some cases, as a customer, you can decide which reference rate you choose. You can take a look at the major banks’ prime rates here and here.
The margin, in turn, is an individualized interest rate set by a bank or other lender. The size of the margin depends on:
- purpose of the loan
- the size of the loan
- The loan period
- collateral and guarantors
- customer’s solvency (income, other loans and credits, compulsory expenses including housing costs)
- customer loyalty (your bank’s key customer relationship or your financial focus will work to your advantage)
- joint applicant (positively affects the marina if you are applying for a loan with your spouse, for example)
- the general economic and employment situation.
The margin specified in the loan agreement generally remains unchanged throughout the duration of the loan. However, margins often have room for negotiation; especially for long-term mortgages, it is advisable to bid on the loan at regular intervals and try to talk down your bank’s margin.
The interest rate controls the general interest rate level
The margin is thus determined by the customer. How then is the reference rate determined? The arbitrariness of banks?
Not exactly. The bank has the power to decide on the monetary policy of the euro area. Therefore, it also decides on the key interest rate that the market rates tend to follow.
If you want to, take a look at the interest rate on the 12-month here.