A personal loan is an unsecured loan. While signing up for this loan, the borrower is not required to provide collateral or security against the loan, unlike in a gold loan where gold jewelry is taken as security by the lender. The interest rates charged on personal loans are thus much higher than on home loans or loans against gold, in order to cover the additional risk undertaken by the lender.
The rates charged are also a combination of various factors – method of calculation, type of rate opted, and individual profile. Let us have a look at some of these factors influencing the interest rate on personal loans.
Personal Loan Interest Calculation Methods
Personal loan interest can be calculated in the following two ways:
a) Flat Rate – In this method, interest is calculated on the total loan amount initially borrowed over the entire tenure of the loan.
b) Reducing Balance method – As you pay off your monthly EMIs, parts of the loan amount and the interest component are paid off. Thus, the principal loan amount keeps on decreasing with time. In this method, interest is calculated on this decreasing loan amount and not the total amount initially borrowed.
Are the personal loan interest rates fixed?
The interest rate on personal loans can be fixed or floating. It is important to understand the difference between the two and analyze which one is more suitable for your financial situation and expectations. There are many reasons you should opt for one, over the other, chief of them being:
- You should opt for a flexible interest rate if you are expecting a dip in the interest rate in the future.
- You should opt for a fixed interest rate if you do not want to take chances of a hike in the interest rate payout.
What are the factors that determine your Personal Loan Interest Rates?
Most lenders consider a number of factors when deciding the interest rate applicable to personal loan applicants. The following are some insights regarding how personal loan interest rates tend to vary depending upon the criteria:
- Income Stability: Your income level, chances of continuity, and income growth guarantee your repayment capability. Thus, these are the first few things checked out by the lender. The higher the repayment capability lower is the risk for the lender and the lower is the return expectation. Similarly, those with lower income, irregular pay, and shorter employment history may be liable to pay higher interest rates as they are perceived as a higher propensity to default.
- Occupation: Whether the applicant is salaried or self-employed can significantly impact the interest rate applicable to a personal loan.
- Salaried applicants, with
- stable employment record
- reputed organizations
- greater income security
- better ability to repay their loan
- Salaried applicants, with
- Occupation: Whether the applicant is salaried or self-employed can significantly impact the interest rate applicable to a personal loan.
tend to get a personal loan at a lower rate of interest than self-employed.
- Age: Individuals who are nearing the retirement age are generally charged a higher interest rate since they are considered as having a higher propensity to default.
- Gender: Certain banks and NBFCs, such as Bajaj Finserv and Fullerton India offer a preferential rate of interest to women. This is in an attempt to promote salaried women, entrepreneurs, and professionals to fulfill their dreams and be financially stable.
- Relationship with the Lender: Customers who have a long-standing with the lender, who have proven themselves to be creditworthy in the past, will be charged a lower interest rate.
- High Credit Score: Applicants with a good credit history and high credit score tend to receive a loan at a lower rate, irrespective of their category. The majority of lenders prefer a credit score of above 650 for personal loan approval
A personal loan is an easily accessible capital that can help you fund your needs quickly. However, it is an additional financial obligation; you should take on after proper consideration.
Whether need help deciding the method and type of rate of interest on your next personal loan, or whether you want to know if a personal loan is a right choice for you right now, feel free to reach out to our Debt Counsellors, we help you get better at credit management.
