07.30.10 | How is my Private Loan Interest Rate Calculated?
If you are applying for a private student loan, you might wonder how lenders arrive at the interest rates they charge on your loan.
Contrary to popular belief, lenders don’t just pull a number out of thin air. In fact, they use one of two financial indexes to determine the interest rate that is then extended to borrowers. The two rates are the Prime Rate and the LIBOR Index.
Prime Rate
The prime rate, which is currently 3.25%, is based on the fed funds rate, the interest rate at which a depository institution lends immediately available funds to another depository institution overnight.
While some lenders have their own version of the Prime Rate, the industry standard is widely considered to be the Wall Street Journal Prime Rate, which is based on the fed funds rate and the average prime rates of the top banks in America. The prime rate tends to change as a result of Federal Reserve monetary policy meetings. These meetings occur about every 6 weeks, or 8 times a year.The fed funds rate is
LIBOR Index
LIBOR stands for London Inter-Bank Offer Rate. It is the interest rate that banks charge each other for loans and is based on the average interest rate paid on deposits of U.S. dollars in the London market. The rate is set by the British Bankers Association and released daily.
Unfortunately, you may not choose which index you want your lender to use. Be sure when browsing for private student loans that you seek out which index the lender uses. It is fairly common for an interest rate to fluctuate depending on the index implemented.
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