It costs money to borrow money. But smart borrowers pay as little as possible for their credit.
If you're in the market for a loan -- whether it's for a mortgage, a home equity loan, a car loan, or just some money to spend -- you've probably noticed how many different rates there are for various types of loans. Getting a mortgage around 6%-7% is pretty easy, but credit cards at those rates are almost nonexistent.
But for many types of loans, what matters most is how much you borrow, compared to what you're buying or financing. In general, you'll get a better deal on your loan if you can put some of your own money toward a down payment on the item -- and the more you can pay, the better your loan will be.
Saving two ways
Of course, it's obvious that the less you borrow, the lower your payments will be. That's one reason why making a sizable down payment when buying a house can help homeowners make ends meet: It keeps those budget-busting monthly payments down.
But there's another way you'll save. Many loans offer better rates when you don't finance the entire cost of what you're buying. By comparing how much you're borrowing to the value of what you're financing, lenders come up with a loan-to-value (LTV) ratio. That number often plays a key role in determining your interest rate.
Adding up the savings
You might be surprised how big a difference your LTV ratio makes. According to Bankrate, the average rate on a $30,000 home equity loan nationwide is currently 6.79%. But if you're using up almost all the equity in your home -- creating a high LTV ratio -- that average rate skyrockets to 8.44%. Even on a relatively small home equity loan like this, that difference alone adds nearly $500 a year to your loan cost.
The limit depends on your lender. At US Bancorp
The reason for this is simple economics: The higher the LTV ratio, the less security your lender has in making the loan. With a lower LTV ratio, your lender can foreclose and potentially recoup the entire amount of its loan.
Driving away with a deal
Car loans similarly have a wide range of rates based on credit score and LTV ratio. It's not uncommon for that range to be as wide as 8%-10%. Although your credit rating plays a big role in determining where you fall in that range, keeping your LTV ratio low can whittle several percentage points from your rate, cutting your monthly payments and saving you hundreds of dollars every year. It can also help with eligibility for incentives from the loan arms of car manufacturers such as Ford
So when you're looking to borrow money, always look into how much you can save by financing a little bit less. The savings from making even a small down payment will often pay dividends for years to come.
To learn more about home equity loans and lines of credit as borrowing options, take a look at our Home Center.
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Fool contributor Dan Caplinger does his best to keep those LTV ratios low. He doesn't own shares of the companies mentioned in this article. US Bancorp is an Income Investor recommendation. The Fool's disclosure policy won't default on you.