If you have been looking for a personal loan for the past couple of days, one thought I am sure which has repeatedly crossed your mind is the various factors which influence the interest rate you are being charged on your personal loan. While the answer to this question might appear to be simple at first glance, in reality, since there is a dearth of fact checked information available on the internet, it can become quite difficult for the average borrower to comprehend the various influencing factors.
Thus, in today’s blog post, we will take a deep dive into the world of personal loan interest rates and share with you exactly the various factors which both positively and negatively affect your personal loan interest rates.
Without further ado, let’s get started.
How Is Your Personal Loan Interest Calculated?
One of the first and most important factors we need to understand is the mechanics behind the calculation of your personal loan interest rates.
Generally, most personal loans across India arrive with a per annum interest rate calculation. In simple terms, this translates to the fact that whatever loan amount you borrow, the lender will charge you a fixed rate of interest on the same, and the calculation will be done yearly.
To simplify this further, let’s use the help of an example.
Suppose you take a personal loan of ₹100,000 with a 12% per annum interest rate. This means that the total amount of interest you will be paying on the ₹100,000 loan per year will be ₹12,000.
Similar to per annum interest rates, some lenders also calculate interest on a monthly or a quarterly basis and thus, it is advised that you check beforehand with the lender about the interest calculation methodology being followed.
Factors Influencing Your Personal Loan Interest Rate
Now that you are familiar with the mechanics of your personal loan interest calculation, shared below are some of the most significant factors affecting your personal loan interest rate.
Irrespective of the lender you choose for a personal loan, one of the first factors they will take into consideration is your credit score. In simple terms, your credit score can be understood as an accurate estimation of your creditworthiness assigned by the credit rating agency. In India, there are three main credit rating agencies, CRIF HighMark, CIBIL and Experian and all of them take into account the following four factors to assign you a credit score on a scale of 900.
The total number of loans you have taken in the past
The total amount of credit you have utilized
The total number of timely payments you have made
The total number of late payments you have made
Taking all these factors into account, every borrower (new or seasoned) is assigned a score on a scale of 900, and generally, you need to have a score of 750 to get approved.
Thus, simply put, the higher your credit score, the lower will be your personal loan interest rate.
Second, to your credit score, another factor considered by lenders in calculating your personal loan interest rate is your monthly income. Since the loan amount you can borrow is directly influenced by your monthly income, it naturally translates to the fact that higher your monthly income, lower will be your interest rate.
For example, if you have a monthly income of ₹15,000, you can expect an interest rate of 12% per annum; however, if it is higher, let’s say ₹25,000, you can expect an interest rate of 10% per annum.
As I shared right at the beginning of this article, one of the primary factors lenders consider while calculating your personal loan interest rate is the loan amount you are borrowing. As the total interest amount you are liable to pay is arrived at after taking into account the loan amount you have borrowed, it has a significant impact on the interest rate the lender extends you.
Simply put, the lower the loan amount you apply for, the lower will be the interest rate offered to you and vice versa.
Next to the loan amount you are borrowing, another important factor considered by lenders in determining your interest rate is the loan tenure you request from the lender. As the risk involved in the loan is directly related to the total tenure you request, it thus translates to the fact that the longer the tenure you request for the loan, the higher will be the interest rate charged on the same.
Along with this, since for a longer tenure, the lender generally takes an increased amount of risk, it is justified that you are being charged a higher rate of interest.
Type of Loan
Last but not least, the rate of interest your personal loan arrives with is also dependent on the type of loan you avail from the lender. Generally, personal loans across India are available in two different varieties, a secured personal loan and an unsecured personal loan, with the latter being the most popular among borrowers.
Now, in a secured personal loan, as the name suggests, you are required to pledge a certain amount of funds as an asset or collateral for security purposes. Since, in this case, the risk for the lender is significantly less, in most cases, the lender will extend you a very affordable rate of interest.
On the other hand, since in the case of an unsecured personal loan, you do not need to pledge any asset or collateral, the risk for the lender is higher, and thus it is only natural that you will be charged a higher rate of interest.
While at first glance, it might appear that the factors influencing your personal loan interest rates are beyond your comprehension, in reality, with a little bit of patience, you can easily understand all of them.
Now that you know of all the factors which affect your personal loan interest rates, what other questions do you have?
Let me know by commenting below, and I will see you in the next one.