Factors That Determine Your Personal Loan Interest Rate 

A personal loan allows you to borrow lump-sum money to pay for a significant expense. It can be used for all kinds of things. Most popular uses for personal loans include covering medical expenses, making home improvements, fixing a vehicle, and covering the costs of funeral expenses. You pay back the money each month until your balance reaches zero. A personal loan can have a fixed or variable interest rate. 

The interest rate affects how much you’re able to borrow. If the interest rate is high, it’s expensive to borrow money. Alternatively, if the interest rate is low, it’s less affordable to borrow money. Interest rates vary among countries. The interest rates for loans in the UK aren’t the same as the interest rates for, say, loans in Canada. Interest rates are a combination of different factors, including time frame, credit risk, policy, and currency. Domestic monetary authorities have no control over the world rate. 

If you’re a borrower, the most important feature to pay attention to is the interest rate. Think about what the costs mean to you. Even the slightest change can impact your ability to pay. Simple interest is often applied to personal loans. To know for sure how much you could end up paying for, multiply the principal amount by the daily interest rate and the number of days until the end of the loan period. 

You’ll want the interest rate attached to your loan to be as little as possible, as it’ll grant a lower payment each month. A surprising number of things can affect your interest rate. Let’s explore them. 

Income level 

Lenders use income to see how likely you are to make your payments each month. If you have a high income and don’t have other obligations, you may be offered a lower interest rate. Alternatively, if your income is pretty low and your payments might be a burden, the chances are you’ll be offered a personal loan at a high interest rate. Your employment status matters as well. Lenders use categories like self-employed, hourly employed, and bonus-based pay to determine if applicants are able to pay back the money. If you’re a freelancer or a gig worker, you should compare and shop around for the best interest rate. 

Credit score 

Your credit score says a lot about your repayment ability. The better the credit history, the better the interest rate. The contrast between a lower and a higher interest rate can lead to a lot of money across the life of the loan. It’s recommended to monitor credit reports from major credit bureaus. Seek errors that can cause a lower credit score. Explain in writing what the problem is, and include copies of supportive documents. You can also contact the company that provided the information to the credit bureau. The address should be listed on the credit report. 

Try to improve your credit score before applying for a personal loan. For instance, use a secured credit card. This will add more positive credit history. The deposit aside, the secured credit card works like any other credit card. No strategy will help you improve your credit score if you don’t pay your bills on time. Some bills are reported to credit bureaus and have a big impact on your credit score. Determine what bills you have and when they are due, figure out how you’re going to pay them. Ideally, you should pay the full balance due on all your bills. 

Amount of money borrowed 

Loan size matters because processing a personal loan involves costs. Your lender will cover these expenses by taking your interest rate a little higher. A high interest rate applies only to an outstanding principal. As a rule, lenders refuse to fund high-principal loans for borrowers considered unqualified. When a person takes on a bigger financial obligation, it’s highly likely that they won’t be able to meet it. If you desperately need some cash, you have no choice but to pay a higher interest rate due to the large balance. How high the monthly payments can be depends on the loan term. The longer the loan terms, the higher interest rate you’ll pay. 

History of default 

Previous repayment records will be verified to see if you’ve been disciplined. A default will negatively impact your ability to get a personal loan. Financial institutions prefer lending to people who haven’t defaulted in the previous 12 months. Even if you get approved, the lender will impose strict rules, as you’ve struggled to repay credit in the past. Personal loans are unsecured. Nevertheless, you can be financed with a secure loan, so look into your options. These debt products are secured by collateral, which can be cash, a car, and even a home. Make sure you can afford the monthly repayments first. 

Interest rate type 

Interest rates fall into two categories: fixed and variable. If you have a fixed interest rate, you’ll pay the same amount for the life of the loan. On the other hand, if you have a variable interest rate, the outstanding balance fluctuates in tandem with an underlying benchmark or index. The variable rate can have an initial fixed period, after which it goes up or down based on the market. Consequently, your payments will vary. Your loan will become more expensive down the line, and there’s the risk of not meeting your payments. You may not be able to plan for cash flow due to changing rates. 

Although lenders use the same basic formula when calculating your interest rate, there are variations in borrower scoring models, which lead to considerable differences in loan rates and terms. To find the best interest rate, you must apply for quotes with at least 3 lenders. Rate shopping helps you figure out what financial product best meets your needs. Lenders will require proof of income, so have recent pay stubs, bank account statements, and tax returns. Don’t lock in the first offer you get. Take the time to shop around.