Credit
How Lenders Decide An Interest Rate
A quoted rate combines the lender's funding cost, expected losses, operating costs and margin, which is why the same applicant is offered different rates by different lenders.
An interest rate looks like a single number set by the lender's choice. It is closer to a sum of four components, and each one moves for different reasons.
Funding cost sets the floor
A lender must obtain the money it lends, whether from deposits, wholesale markets or its own capital, and that has a price driven by prevailing rates.
Because funding cost applies across the whole book, a general move in market rates shifts every lender's floor at roughly the same time.
This is why quoted rates across the market move together even though lenders set them independently, and why individual circumstances explain only part of a rate.
Expected loss is priced into the individual rate
Lenders estimate what proportion of similar borrowings will not be repaid and price that expectation into the rate charged to that group.
An applicant assessed as higher risk is not being penalised for a prediction about them individually; they are being priced within a category.
Security reduces this component sharply, which is the main reason secured borrowing is cheaper than unsecured borrowing at the same amount.
Operating cost falls disproportionately on small loans
Assessing, issuing and administering a loan costs a broadly similar amount regardless of size, so that cost is a larger share of a small advance.
Expressed as an annual rate, a fixed cost on a small, short borrowing produces a very high number, which is part of why short-term credit rates look extreme.
Some products recover this through fees instead, which moves the cost out of the interest rate without removing it from the total.
Margin reflects competition and appetite
The remaining component is the lender's return, and it varies with how much business the lender wants in a particular segment at a particular time.
Appetite changes, so the same applicant with unchanged circumstances can be quoted differently across a year as lenders adjust what they are targeting.
This is the component that explains why shopping around produces different answers, and why one decline does not indicate a general position.
Risk-based pricing means the quote follows assessment
Advertised rates are generally available to a proportion of successful applicants rather than all, with others offered a higher rate after assessment.
Disclosure rules in many jurisdictions require this to be stated, though the specifics vary by jurisdiction and change over time.
Comparing the rate actually offered rather than the advertised one is therefore the only meaningful comparison, and it is available only after applying or obtaining a quotation.
