Personal loans are one of the most popular options because of their versatility. You can use the loan amount for any purpose, including paying for home renovation, planning a wedding, or financing a vacation. Many lenders provide an instant loan app to make the loan process smoother and quicker. Since personal loan interest rates vary from lender to lender and from borrower to borrower, it cannot be very clear to understand what affects your interest rate.
In this blog, discover the benefits of a quick loan and the factors influencing interest rates.
Benefits of a personal loan
Personal loans have many benefits. Some of them include the following –
- The documentation required is minimal, so the processing time for the loan is also less.
- No restriction on the usage of the loan amount.
- You don’t need collateral to get a personal loan.
- A personal loan is a quick loan, and the process of applying is hassle-free.
- Depending on the purpose of the loan, you can also claim tax benefits on interest payments.
Factors that influence personal loan interest rates
Since personal loans are unsecured, their interest rate tends to be higher than other types of loans. Different lenders charge different interest rates. Therefore, they consider many factors while determining the interest rate.
Some of the factors that influence the interest rate are as follows.
Your Income
Your income plays an integral role in determining your interest rate. It helps the lender decide if you are a risky borrower and whether you can repay the loan. The lender will charge a higher interest rate if you are a risky borrower. This is because high-risk borrowers have a higher chance of defaulting on repayment.
If you have a high income, the lender will be assured of your ability to repay the loan and may charge a lower interest rate. Thus, it is very important to mention if you have any additional income apart from your monthly salary. This might help you secure a loan at a lower interest rate.
Credit score
The credit score is one of the most significant factors that affect your interest rate. Your credit score is proof of your creditworthiness. The higher your credit score, the better your chances of getting a loan. The credit score also impacts the interest rate at which different lenders will offer you the loan.
A poor credit score reflects poor repayment behavior and marks you as a risky borrower. To balance this risk, lenders increase the interest rate on your loan account. That’s why you must check your credit score before applying for a personal loan, and in case your credit score is poor, you must take the necessary steps to increase your credit score.
Debt-to-income ratio
Even if you work in a reputed organization and earn a substantial salary, you may not get a low-interest rate if you have a high debt-to-income ratio. The debt-to-income ratio shows the balance of your total debts to your total income. A higher DTI means a significant portion of your income is going to debt repayment, making you a risky borrower. And the lender will charge high-interest rates from you.
Employer
Since personal loans are unsecured, lenders tend to look at all possible factors while determining your interest rate. Apart from your income, your employer also plays a role in deciding your interest rate. If you work with a reputable organization, like a government organization or a multinational company, the lender will see you as more financially stable. They may extend you the loan at a lower interest rate.
Similarly, suppose you work in a relatively unknown organization or a start-up or as an independent professional, in that case. In that case, your chances of getting a low-interest-rate personal loan are low. This is because of the common job security at such organizations.
Relationship with lender
The relationship you share with a potential lender significantly impacts your interest rate. The lender may charge a low-interest rate to their loyal and long-term customers. That is why taking a loan from a lender with whom you already have a relationship is advisable. This also helps in reducing the processing time of your loan.
Default history
Most lenders prefer giving loans to people who haven’t defaulted on a payment in the last 12 months before applying for a loan. If the lender discovers defaults, they will see you as a high-risk borrower and thus charge a high-interest rate. They may even reject your loan application.
Economic climate
The economic climate, including factors like inflation, repo rate, etc., directly influences the interest rates. For example, lenders will charge a higher interest rate if there is inflation. Similarly, during a recession, they will charge a lower interest rate.
Things to remember before taking a personal loan
A personal loan is a huge step, even if it seems straightforward and hassle-free. Remember the following things before taking a loan.
- Maintain a high credit score.
- Try to borrow during a low-interest rate time.
- Calculate your EMI beforehand to reduce your financial burden.
- If you already have a loan, borrowing from the same lender will increase your chances of getting a low-interest rate.
- Do your research and carefully consider several lenders before selecting one. Personal loan interest rates vary, and you should look for the best possible rate.
The factors discussed in this blog can help you make a smart borrowing decision. Consider them carefully before applying for a personal loan. Maintain a good repayment record. Use an EMI calculator to decide what tenure and interest rate will suit you the best.
References:
https://www.fullertonindia.com/knowledge-center/factors-affect-personal-loan-interest-rates.aspx