Factors that affect the personal loan interest rate

by | Jul 5, 2019 | 0 comments

By Author: neha sharma

A personal loan is a very popular loan option for borrowers. This is because a personal loan is both unsecured and unconditional. This means the borrower can use the personal loan for any purpose without any conditions set by the lender. However, most lenders expressly bar a few fund uses such as speculative investing or gambling to protect the loan amount. Apart from these conditions, personal loans can be used for different purposes such as:

• Wedding expenses
• Medical emergencies
• Travel expenses
• Business expansion
• Home improvement
• Consumer durable purchase and many others

One of the reasons for a personal loan’s affordability is the reasonable interest rates. Personal loans given out by most lenders command an interest rate between 10% to 40% with most loans being given out for rates between 10% and 20%. The huge disparity between the personal loan interest is because there are different factors that lenders consider when they fix the interest rate. These factors differ from person to person. Lenders set the personal loan interest rates on a case to case basis after thoroughly examining the borrower’s application. This due diligence is done to assess the risk of each application and to protect the lender’s capital.

These are the factors that affect personal loan interest rate:

1. Income of the borrower:
This is one of the major criteria for a lender. Some lenders expressly set minimum monthly income guidelines to ensure the loan applicants bring in income to pay off the personal loan installments. This income mostly includes income from employment. Some lenders may also consider investment incomes. In case of a joint loan application, the total combined income of the joint applicants is considered while setting the interest rate.

Lenders also verify the regularity of the income and also check the employer’s reputation. They may also require details of business for a self employed person to check the profits in the business.

2. Credit score:
The credit score is an indication of repayment history, loan applications made, types of debt and payments etc. While there is no set credit score for a loan application, generally, any score above 700 is considered For each personal loan application, the lenders contact the credit bureaus to get an exhaustive credit report.

3. Purpose of the loan:
Even though lenders do not put any conditions on the use of funds, they require information about the purpose for which funds are going to be used. If the borrower is to use the funds for any purpose that the lender perceives to be risky, the rate of interest on the loan will be higher.

4. Loan amount:
This factor is not looked at in isolation, but in combination with the income and credit score. Based on the monthly income and credit score, lenders generally estimate an amount for which the borrower is eligible. If the borrower requests for a loan lesser than the eligibility, the personal loan interest rate is lower. On the contrary, if the loan amount is high, the lender may consider the application risky and charge a higher rate of interest.

5. Outstanding loans:
A lender is usually very interested to check the outstanding loans that a borrower has, especially the types of loans. Borrowers having unsecured loans such as personal loans and credit card debt are seen as risky borrowers and their loan applications have a higher personal loan interest rate. However, borrowers having secured loans may get a lower rate of interest on their loans. Lenders also check the ratio between outstanding loans and the monthly interest rate. If this ratio exceeds 50%, then either the loan application is rejected or it commands a high interest rate.

Author bio:

Neha Sharma is a finance student who loves to write in her free time. She has spent considerable time researching about personal loan interest rate. Through her work, she has listed factors that affect interest rates


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