Why Do Interest Rates on Loans Change?

When applying for a loan in the Philippines, one of the first things borrowers look at is the interest rate. This rate determines how much you will pay on top of the borrowed amount, making it a critical factor when choosing a loan. However, you may notice that interest rates are not always the same. Sometimes they go up, and other times they go down. But why do interest rates on loans change? Understanding the reasons behind these fluctuations can help Filipinos make informed financial decisions and better manage their loans.

Understanding Interest Rates

At its core, an interest rate is the cost of borrowing money. It’s what lenders charge borrowers for providing funds, allowing them to use money they do not yet have. For lenders, interest rates serve as compensation for the risk they take and the service they provide.

Interest rates are often expressed as a percentage of the loan amount, applied annually (also known as the annual percentage rate or APR). Higher interest rates mean borrowers pay more over the life of the loan, while lower interest rates reduce the overall cost.

Factors That Affect Loan Interest Rates

1. Inflation Rates

Inflation plays a major role in determining interest rates. Inflation refers to the rising prices of goods and services over time, which decreases the purchasing power of money. When inflation is high, lenders may increase interest rates to ensure that the money they get back from borrowers retains its value.

For example, if you borrow PHP 100,000 today and repay it over five years, inflation could reduce the value of that money by the time it’s returned. To compensate for this loss, lenders charge higher interest rates during periods of high inflation.

2. Supply and Demand for Credit

Interest rates are also influenced by the supply and demand for loans. If many Filipinos are borrowing money, lenders may increase rates to balance demand with their available funds. On the other hand, if fewer people are borrowing, lenders may lower rates to attract more borrowers.

3. Monetary Policy

The Bangko Sentral ng Pilipinas (BSP), the country’s central bank, also influences interest rates. Through its monetary policy, the BSP adjusts the policy rates, which are the rates it charges banks for borrowing money. When the BSP raises policy rates, banks and lenders tend to raise loan interest rates to cover their higher borrowing costs. Conversely, when the BSP lowers rates, lenders may also lower loan interest rates.

4. Risk of Default

The risk level associated with lending to a particular borrower also affects interest rates. If a lender perceives a borrower as a higher risk—due to low income, limited credit history, or unstable employment—they may charge a higher interest rate to compensate for the increased risk.

Borrowers with good credit history and stable financial backgrounds typically receive lower interest rates because they are seen as low-risk.

5. Loan Type and Term

The type of loan also influences the interest rate. For example:

• Secured loans (like home or car loans) usually have lower interest rates because the lender can seize the collateral if the borrower defaults.
• Unsecured loans (like personal loans) tend to have higher rates since they lack collateral.

The length of the loan term can also affect the rate. Shorter-term loans generally have lower rates than longer-term loans, which carry more risk due to the extended repayment period.

Economic Conditions and Global Events

1. Economic Growth

When the Philippine economy is growing, businesses and individuals tend to borrow more to finance expansions and investments. This increased demand for loans can drive interest rates up. Conversely, during economic downturns, borrowing tends to decrease, which can lead to lower interest rates as lenders compete for fewer borrowers.

2. Global Events and Financial Markets

The global economy can also influence local interest rates. International events such as financial crises, changes in global commodity prices, or pandemics can create economic uncertainty. In response, central banks (including the BSP) may adjust interest rates to stabilize the economy, indirectly affecting loan rates.

Administrative Costs

Lenders incur costs related to processing, approving, and managing loans. These operational expenses can vary based on technological investments, regulatory compliance, and staffing requirements. If administrative costs increase, lenders may pass these expenses onto borrowers in the form of higher interest rates.

Competition Among Lenders

In the Philippines, banks, cooperatives, online lenders, and financing companies all compete for borrowers. In competitive markets, lenders may lower interest rates to attract customers. In less competitive markets or in areas where fewer lending options exist, lenders may charge higher rates because borrowers have fewer alternatives.

How Borrowers Can Benefit

1. Monitor Economic Trends

Keeping an eye on economic news, inflation reports, and BSP announcements can give you an idea of where interest rates are headed. This can help you decide when to apply for a loan to secure more favorable terms.

2. Improve Your Creditworthiness

Borrowers with good credit scores and strong financial profiles have better chances of securing lower interest rates. Paying bills on time, reducing debt, and maintaining stable employment can all help improve your credit standing.

3. Compare Offers from Multiple Lenders

Don’t settle for the first loan offer you receive. Compare interest rates from different banks, cooperatives, and financing companies to find the most affordable option for your needs.

4. Consider Fixed vs. Variable Rates

Some loans offer fixed rates, which stay the same throughout the loan term, while others offer variable rates, which change based on market conditions. If you prefer predictable payments, a fixed-rate loan may be better. However, if rates are expected to drop, a variable-rate loan might save you money.

Final Thoughts

Interest rates on loans change for various reasons, from economic factors and government policies to individual borrower risk and market competition. Understanding these factors can help you make more informed borrowing decisions and potentially save money on interest payments.

If you’re planning to apply for a loan, take the time to understand current interest rate trends, improve your financial profile, and compare options to find the best loan for your situation. By doing so, you can secure a loan that fits your budget and helps you achieve your personal or business goals.