What Affects Annual Percentage Rate

The single biggest factor affecting annual percentage rate is the Federal Funds Rate, set by the Federal Reserve, which decreases the annual percentage rate by 0.25% for every 0.25% decrease in the Federal Funds Rate, as seen in the case of Wells Fargo, which lowered its prime lending rate from 5.5% to 5.25% after the Federal Reserve cut the Federal Funds Rate from 2.25% to 2.0% (Federal Reserve Economic Data).

Main Factors

• Inflation Rate — the higher the inflation rate, the higher the annual percentage rate, as lenders increase interest rates to keep pace with inflation, for example, when the inflation rate rose from 2% to 3%, the annual percentage rate on a 30-year mortgage increased from 4% to 4.5% at Bank of America.
• Credit Score — a higher credit score decreases the annual percentage rate, as lenders view borrowers with higher credit scores as less risky, for instance, a borrower with a credit score of 750 may qualify for a 5% annual percentage rate on a car loan, while a borrower with a credit score of 600 may be charged a 7% annual percentage rate at Toyota Financial Services.
• Loan Term — longer loan terms increase the annual percentage rate, as lenders take on more risk over a longer period, for example, a 5-year car loan may have an annual percentage rate of 4%, while a 7-year car loan may have an annual percentage rate of 5% at Ford Motor Credit Company.
• Market Conditions — changes in market conditions, such as shifts in supply and demand, can vary the annual percentage rate, for example, when the demand for mortgages increased during the housing market boom, the annual percentage rate on a 30-year mortgage rose from 4% to 6% at JPMorgan Chase.
• Type of Loan — different types of loans have different annual percentage rates, for example, a credit card loan may have an annual percentage rate of 18%, while a mortgage loan may have an annual percentage rate of 4% at Citibank.
• Lender's Risk Assessment — lenders' risk assessments of borrowers and loan types can increase or decrease the annual percentage rate, for instance, a lender may charge a higher annual percentage rate to a borrower with a history of late payments, such as 10% at Capital One, while a borrower with a good credit history may be charged a lower annual percentage rate of 6% at Discover Financial Services.
• Regulatory Environment — changes in regulations, such as the Truth in Lending Act, can decrease the annual percentage rate by increasing transparency and competition among lenders, for example, the introduction of the Credit Card Accountability Responsibility and Disclosure Act led to a decrease in the annual percentage rate on credit cards from 20% to 15% at American Express.

How They Interact

The interaction between Inflation Rate and Federal Funds Rate can amplify the effect on the annual percentage rate, for example, when the inflation rate rose from 2% to 3% and the Federal Reserve increased the Federal Funds Rate from 2.25% to 2.5%, the annual percentage rate on a 30-year mortgage increased from 4% to 5.5% at U.S. Bank. The interaction between Credit Score and Lender's Risk Assessment can also decrease the annual percentage rate, for instance, when a borrower with a credit score of 800 applies for a loan, the lender may charge a lower annual percentage rate of 4% due to the borrower's low risk profile, as seen at PNC Financial Services. The interaction between Market Conditions and Type of Loan can vary the annual percentage rate, for example, when the demand for mortgages decreased during the housing market downturn, the annual percentage rate on a 30-year mortgage decreased from 6% to 4% at BB&T.

Controllable vs Uncontrollable

The controllable factors are Credit Score, Loan Term, Type of Loan, and Lender's Risk Assessment, which are controlled by the borrower and the lender, respectively. Borrowers can control their Credit Score by maintaining a good credit history and making timely payments, which can decrease the annual percentage rate, for example, a borrower who improves their credit score from 600 to 750 may qualify for a lower annual percentage rate of 5% on a car loan at Honda Financial Services. Lenders can control the Loan Term, Type of Loan, and Lender's Risk Assessment, which can increase or decrease the annual percentage rate, for instance, a lender may offer a shorter loan term with a lower annual percentage rate to attract more borrowers, such as a 3-year car loan with an annual percentage rate of 3% at Volkswagen Credit. The uncontrollable factors are Federal Funds Rate, Inflation Rate, Market Conditions, and Regulatory Environment, which are controlled by external entities such as the Federal Reserve, economic conditions, and government regulations.