Loan Talk: Understanding The Unseen Factors That Determine Personal Loan Interest Rates

Even saving a tiny percentage on loan interest rates can help you save thousands of rupees over the loan’s tenure. So, it definitely pays to be aware of the different factors that determine your loan interest rates.

Personal loans have immensely grown in popularity in the last few years. Thanks to the presence of digital lenders, it’s easier than ever before to get a personal loan. These unsecured loans do not require collateral and can be used to meet any of your emergency cash needs. Whether you’re looking to pay for a medical emergency, your child’s education or wedding, home renovation, gadget shopping, or a vacation – personal loans are the hassle-free choice.

Even if this is your first time taking a personal loan, you probably know that the lower the interest rate, the better it is for your pocket. The interest rate offered on personal loans plays a crucial role in determining your overall loan burden.

Do you know that the interest rate offered by banks and other lenders vary from one borrower to another? Consider this scenario – you and your friend approach a bank and apply for the same loan product. You may be offered a lower interest rate, while your friend may be charged with higher rates or vice versa.

The lender fixes your interest rate after considering several factors. Understanding the factors that determine the interest rates can help you make smarter choices while applying for a personal loan. Knowing these factors can help you negotiate with your lender, helping you land the best deal on a loan.

Here are the 5 key factors that determine your personal loan interest rates:

  1. Your Credit Score

The higher the credit score, the lower is the interest rate you’re offered.

You probably know that your credit score plays a crucial role in determining your loan eligibility. Not just the approval, credit scores also determine the interest rate you’re charged with.

Having a high credit score definitely helps. Credit scores reflect the financial performance of an individual. It determines whether you’re creditworthy or not. A high credit score indicates that you’re responsible for debts. It shows that you have made timely payments on your previous loans and have not overstepped your available credit. Simply put, a good credit score creates a good impression on the lender, helping you enjoy reduced interest rates on your loans.

Credit scores range from 300 to 900, and a score over 750 is considered as good. If you have an impressive credit score, then you can be assured of the best interest rates. You can even negotiate with the lender to bring it further down. On the other hand, if your credit scores are low or bad, then the lender may not sanction your loan request. Even if the loan is granted, you will be slapped with higher interest rates.

So, before you apply for a personal loan, you must be aware of your current credit score. You can check your credit score for free by visiting CreditMantri. Powered by Equifax, CreditMantri helps you check your current score while also providing you with a personalised action plan on how to improve your credit score if needed.

  • Your Debt-to-Income Ratio

The higher the DTI, the higher is the interest charged on your personal loan.

Consider this scenario – you earn a high salary and are employed in a well-known organisation. You have already taken several debts like a home loan, car loan, and an education loan. In this case, you’re likely to be charged a higher interest rate, even though you hold a steady job and earn a relatively high salary package.

This is because your DTI (Debt-to-Income) ratio is high. The DTI is calculated by dividing all your outstanding debts by your total income. The higher the DTI ratio, the higher is the interest rate on your loans.

  • Your Income

Your income plays a crucial role in determining personal loan eligibility as well as interest rates. Lenders look for borrowers who are more likely to repay the loan on time and without any defaults. When you have a stable income, it gives confidence to the lender that you will repay the loan on time.

However, remember that your income is one of the many factors that determine your loan eligibility. For example, let’s assume that a loan applicant earns Rs. 1 lakh per month. But, if he/she already has a high debt-to-income ratio, then it may be difficult to get a personal loan. And, even if approved, the interest rates may not be favourable.

On the other hand, another borrower with a lower pay package but lower debt burdens may enjoy reduced interest rates.

  • Your Profession & Employment History

A steady job with a stable income helps you avail of lower interest rates.

Personal loans are unsecured – meaning you don’t have to submit any collateral. This increases the risk borne by the lender. Hence, lenders consider other factors like your profession to offset the risks.

If you’re employed in a reputable and well-known institution, you’re likely to be offered lower interest rates. Similarly, if you’re a professional – doctor, dentist, lawyer, chartered accountant – holding a steady practice, then you can enjoy lower interest rates.

When it comes to self-employed individuals, the lender checks the nature of your business, how long you have been in business, profit, and loss statements – to determine your eligibility and interest rates. If you have recently switched jobs or working temporarily, then the lender is likely to charge you a higher interest rate on your personal loan.

  • Finally, Your Previous Relationships with the Lender

The more loyal you are to a lender, the lower are the interest rates.

In the world of finance, a lot rests on trust and loyalty. Generally, banks and NBFCs offer preferential interest rates to existing customers. This is because they know the customers well and are aware of their financial behaviours. Additionally, lenders look to retain existing customers by offering them lower interest rates. So, applying for a personal loan at a lender with whom you have a long-lasting banking relationship is likely to land you a better deal.

However, note that this may not always be the case. New-age digital lenders offer competitive interest rates to new customers to widen their customer base.

Wrapping Up

The five factors listed above are the significant elements that determine your personal loan interest rates. Besides these factors, other minor factors can also affect your interest rates. For example, generally, lenders offer lower interest rates for loans of short-tenures and lower amounts. Sometimes the negotiation skill of the borrower can also play a role in further reducing interest rates.

Understanding all the factors that determine your loan interest rates can help you land the best deal. Finally, always shop around, compare offers, and choose the best one for you.

Using a loan aggregator site like CreditMantri can help you get the list of all offers matched to your credit profile. You can then compare the features, interest rates offered by different lenders and select the best deal for you, all within a few minutes. If you’re interested in a personal loan, visit CreditMantri to start analysing the best deal for you.

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