Personal loans have witnessed a huge surge in demand and continue to grow at a rapid rate. People may require quick personal loans to settle their different financial needs, be it a wedding, vacation, tuition fee, event organising, renovation projects, medical emergencies etc. Being multipurpose, typically unsecured, and in some cases, no credit score checks, make personal loans well suited for most people and also explain their growing demand.
As tempting as they sound, there are still a few things that should be considered before applying for a personal loan. Even if you have ascertained your ability to make full repayment of a potential personal loan, interest rates can still be a major factor affecting your repayments.
For home loans and car loans, the rate of interest is fixed for all borrowers. But personal loans’ interest rates are constantly fluctuating and may be different for each borrower depending on the eligibility criteria set by the lender. Therefore it is highly recommended to know all the important factors that can affect your personal loan interest rate.
Here are some key factors that can or will affect the interest rate on your personal loan:
1. Your Income
Your income is the most critical element that determines the interest rate on personal loans. It’s an obvious truth that individuals with high income are more likely to fully repay their loans on time than those with lower incomes. High income of a borrower provides a greater level of confidence in borrower’s repayment capacity.
It can be easily observed in the lending sector that individuals with high and stable income tend to get away with lower interest rates on their loans. However, lenders may levy higher interest rates on loans given to low-income individuals to safeguard themselves against potential risks.
2. Your Credit Score
It is common knowledge nowadays that credit score plays a critical role in loan approvals. However, for personal loans, your score becomes even more significant because it will not only decide the loan approval but also impact the interest rates. The credit score reflects the financial performance of a person in terms of previously taken loans or other credits.
Each timely repayment against your loan will increase your credit score while delayed payments or defaulting will have negative effects. In other words – taking an instant loan can boost your credit score. A higher credit score conveys a higher level of trust in the borrower’s repayment ability, allowing them to take loans at lower interest rates. Typically, a score above 750 is considered a good credit score.
However, many digital lending platforms such as personal loan apps provide personal loans online for bad credit scores.
3. Your Employer’s Status
Since personal loans are typically unsecured, lenders seek different factors that provide some trust in borrowers, and the reputation of your employer is one among them. The reason behind this logic is fairly simple. Borrowers who are employed in a renowned organisation are considered more financially stable and responsible for making timely repayments. Sometimes, lenders may also have more relaxed lending policies borrowers working for specific organisations.
4. Your Debt-to-income Ratio
Assume you are employed in a well-known company and earn a relatively high salary, but you have a decent part of your salary going in debt payments. In this scenario, all your previous debts are certainly going to affect the interest rate on any potential personal cash loan. Debt-to-income ratio is calculated by dividing all your debt payments by your total income. A higher debt-to-income ratio means more obligations on the borrower’s part, and the lender may charge a higher interest rate on your loan just to be on the safe side.
5. Your Relationship with the Lender
Developing a sense of trust in one another after interacting for longer periods is part of human nature, and this is also true for you and your lender. Banks usually are more lenient in charging interest rates when lending to a trusted customer. However, this trust doesn’t build overnight. It takes a lot of time and responsible behaviour by customers of the bank to maintain their loyalty. When lenders see your loyalty toward their institution, they are likely to offer you a better deal than what newer customers would get.
Apart from the above-mentioned factors, several other smaller elements can affect your personal loan interest rate. For example, some lenders may offer you a lower interest rate if the loan tenure is short. Individual negotiation skills may also be effective in getting a good deal sometimes. Nonetheless, by knowing all the elements that factor into personal loan interest rates, a person can be better prepared when applying for a loan.