Before applying for a personal loan, applicants assess the offers made by a number of lenders and banks. The most crucial component of the offer is the interest at which the personal loan is given to an individual. An applicant must have an idea about the prevailing rate of interest of personal loan before they can select the right one for them.
Usually, a rate of interest that is below the national average, is considered to be a good interest rate. In India, the average percentage of interest on a personal loan is between 9% and 22%. In practice, the interest rate granted to a personal loan applicant depends on a number of factors such as their credit score, employment situation, debt-to-income ratio, the loan amount and term, as well as the collateral pledged against the loan amount.
Factors affecting interest rate
Credit score: An applicant’s credit history and credit score are analysed by a lender to get a sense of their creditworthiness and ability to repay the loan. The higher your credit score, the better are the chances of getting a low rate of interest.
Employment and income: An applicant who is a salaried employee of a reputable organisation such as a government employer, bank or multinational company may be granted a lower rate of interest.
When compared to self-employed individuals, those earning a steady income as a salary have a better chance of getting low interest rates. Naturally, those earning a higher income also have a better chance to repay the loan, meaning the risk is lower for the lender. This usually translates to a lower rate of interest for personal loan.
Loan amount and term: If the total loan amount applied for by an individual is large, the risk for the lender is also sizable. So, the interest rate is also higher. On the other hand, when the principal amount is low, the interest rate is also low.
Meanwhile, the term over which the loan has to be repaid affects the interest rate as well. Longer loan repayment terms come with higher rates of interest and vice versa.
FOIR and credit utilisation ratio: The fixed obligation to income ratio (FOIR) refers to the portion of a person’s income that will go towards repaying the EMIs. If your FOIR is more than 50%, a lender will give you a higher rate of interest for a personal loan.
Credit utilisation ratio is the ratio of the credit used to the total credit available. A credit utilisation ratio of less than 40% is considered to be eligible for low interest.
Conclusion
To get a clearer picture of the interest payable to the lender, applicants can use the flat rate method and reducing balance method. The flat rate method calculates the rate of interest of personal loan using the total amount of loan borrowed initially over the tenure of the loan. The reducing balance method calculates the interest on the principal amount as it decreases with time, instead of the total amount borrowed.
Those looking to get a personal loan can get lower interest rates by maintaining a healthy credit score, FOIR and credit utilization ratio. They must remember that their employment status and income also affect the rate of interest at which the loan will be given to them, and can make efforts to minimize the interest. Head over to a trusted platform like Finserv MARKETS for the same!
