Personal loans can be an excellent solution if you are seeking collateral-free funds. However, one crucial element that significantly impacts the total repayment amount is the interest on your loan.
Several factors influence the personal loan interest rates offered by lenders. These include credit score, income and employment type, existing relationship with a lender, defaults, debt-to-income ratio, loan tenure, loan amount, and age.
In this article, we will take a closer look at these aspects to understand what affects interest rate calculations.
7 Factors that Affect Personal Loan Interest Rates
Here are the key factors lenders consider when determining your personal loan interest rates:
1. Credit Score
One of the first things lending companies look for while assessing an applicant’s form is a good credit history, summarised by your credit score. It is one of the best indicators of responsible financial behaviour and can help lenders decide whether they can pay back the loan on time.
A score of 750 and above is ideal for improving your chances of securing a personal loan with low interest rates.
To improve your score, make timely payments on EMIs and credit cards, maintain a diverse credit mix, and keep your credit utilisation ratio at or below 30%.
2. Income and Employment Type
A stable income source is a significant factor in determining your interest rates. Salaried individuals with regular income are often viewed more favourably compared to those with variable income sources, such as freelancers or self-employed individuals. The latter may need to provide additional documentation, such as tax returns, to demonstrate their income stability.
3. Relationship With Lender
Having a good relationship with your lender can positively impact your loan terms. Borrowers who have previously demonstrated responsible borrowing behaviour – such as timely repayment of loans – may qualify for lower personal loan interest rates. It’s essential to maintain good credit with all lenders, as a history of missed payments can weaken your negotiating power.
4. Defaults
Defaults, which include missed or delayed EMI payments, can severely affect your creditworthiness. Lending institutions analyse payment history meticulously, and patterns of poor financial management can lead to higher interest rates or even loan rejection. To secure reasonable rates, it’s best to minimise defaults.
5. Debt-to-Income Ratio
Lenders consider your debt-to-income (DTI) ratio to assess your overall financial health. This ratio compares your monthly debt payments to your gross monthly income. Ideally, keeping your DTI ratio below 30% can enhance your chances of qualifying for loans with attractive interest rates. A lower ratio demonstrates that you have sufficient resources to manage additional debt responsibly.
6. Loan Amount and Tenure
The loan amount and tenure play significant roles in determining personal loan interest rates. Generally, if you borrow a larger amount, lenders might charge a higher interest rate. This is because larger loans carry more risk for the lender; if you default, they stand to lose more money.
Similarly, you may get a higher interest rate for a longer repayment period. This is because the longer the loan is outstanding, the greater the chance that economic conditions or your personal circumstances could change, increasing the lender’s risk.
7. Age
Age also plays a role in lending decisions. Younger borrowers are often perceived as having greater earning potential due to their longer working years ahead, which may result in lower interest rates. However, lending firms usually set a minimum age requirement for applicants, so as to meet legal age requirements and give them sufficient time to establish stable employment or a steady income stream. Older applicants with strong credit histories can also qualify for competitive rates, though those nearing retirement age may face challenges in securing favourable terms.
Conclusion
Knowing the factors that influence personal loan interest rates is essential for borrowers seeking the best possible loan terms. By focusing on key elements such as credit score, income stability, and responsible financial behaviour, you can improve your chances of securing a loan with lower interest rates.
Well-known lending institutions such as SMFG India Credit provide a personal loan EMI calculator. This easy-to-use tool helps you visualise how various interest rates affect your monthly payments, enabling informed decisions about the most suitable loan option for your needs.
*T&C apply. Loan eligibility, loan terms, and loan disbursement processes are subject to the lender’s policy at the time of loan application.
