Interest Rate

• The basis of your lending rate is the simple interest rate. This is the rate that the bank will charge you expressed as a percentage. If your loan was for $10,000 and you had an interest rate of 7 percent, your loan would accrue $700 in interest after one year if no payments were made. The simple interest rate will tell you the basic information about how much your bank is charging you on a yearly basis. Keep in mind that if you make payments over the course of the year that lower the principal amount of your loan, the amount on which the interest is being charged will go down and so will the amount of interest you pay.
  
  

Index

• In order to determine the simple interest rate it will charge you, the bank will usually rely on an index. An index is a rate that represents the most current state of the economy and the lending market. This rate is usually published on a national level so that all banks can use it if they wish. The rate will fluctuate with financial conditions; when there is a lot of demand for loans, it will be high. If demand for credit is low, indexed rates will be, too. One of the most prevalent indexes for banks to use is the prime lending rate, and it is published in The Wall Street Journal.
  
  

Margin

• Although a bank's lending rate is based partially on an index, that is not the entirety of the rate. Banks often also rely on a margin, which is a percentage that they add to the indexed rate. For example, if you apply for a home equity line of credit, the bank may tell you that the rate is prime plus 1.75 percent. This means that it will charge you whatever the current prime lending rate is and add 1.75 percent. On a credit product with a variable rate, the fluctuation of the indexed rate is what will cause the rate to change and the margin will remain constant.
  
  

Annual Percentage Rate

• An index and a margin make up the simple interest rate, but the true annual percentage rate associated with your credit product is more complex. Federal Deposit Insurance Corp. Regulation Z states that "the annual percentage rate is a measure of the cost of credit, expressed as a yearly rate." While the interest rate only shows the amount of interest you will be charged annually, an APR also reflects any applicable fees that you are charged in connection with your account. These fees are added in to the interest rate so that the APR you see as part of your bank lending rate gives you a true picture of how much the loan or line of credit will cost you.
  
  

Rate Shopping

• The most important aspect of understanding what makes up your bank lending rate is the ability to put that knowledge to use when making financial decisions. When contemplating applying for a loan or line of credit, it is best to shop your local banks to find the best rate. Completing this process will help you save money over the course of your loan and will ensure that you have the best product for you. If a bank tells you what interest rate it is charging you, it is most important to consider what the margin it is using is. Compare margins from bank to bank, and the one with the lowest margin will save you the most money in the long run. Additionally, the APR is more important than the interest rate because it portrays a larger scope of the cost of credit. The lower the APR, the less money you will pay overall.