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3 Primary Ways to Ensure a Good Interest Rate on Your Personal Loan

Published on May 1, 2024Updated on May 20, 2024

3 Primary Ways to Ensure a Good Interest Rate on Your Personal Loan

A personal loan can help you cover an unexpected medical bill, home repairs, credit card payment, or even a wedding. Quick disbursement procedures and minimal documentation requirements have made personal loans the preferable option for those in need. 

However, securing a low-interest rate is crucial for minimising the cost of borrowing and managing finances effectively.

By the end of this article, you will have an idea of what a good interest rate is and 3 primary strategies to ensure you increase your chances of getting the same on your next personal loan application.

Overview of Interest Rate

Every rupee you borrow comes with an interest rate. This rate determines the cost of borrowing, having a direct impact on whether your dream car or vacation fits your budget. Understanding how interest rates affect your debt will help you make informed financial decisions that can strengthen your loan application.

The interest rate attached to your loan plays an important role in determining how much you have to pay back on borrowed funds. Essentially what this means is that the higher your interest rates are, the higher will be your cost of borrowing. 

Factors that Affect your Interest Rate

Several factors come into play when applying for a personal loan that can influence the interest rate that lenders will offer you. By having an understanding of these factors, you can navigate the borrowing process more effectively and potentially secure a lower interest rate. Let us discuss a few of the factors below:

Credit Score

An individual’s creditworthiness is determined by a three-digit numerical value that is based on their credit history and overall financial responsibility – credit score. Credit scores usually range from 300 to 900, where scores of 750 and above are generally deemed to be excellent.

A good credit score may lead to a lower interest rate because it indicates a lower risk for the lender. Conversely, a lower credit score translates to a higher interest rate in order to compensate for the lender’s increased risk. 

Employment History and Stability

In personal finance, your employment history holds significant influence over your ability to secure loans on favourable terms. Lenders scrutinise your employment background to gauge your financial stability and capacity to repay debts. 

Your financial stability is reflected in your employment history and shows your ability to generate a consistent income stream. Lenders view a consistent employment record as an indicator of your capacity to repay a loan on time and in full.

Lender-borrower Relationship

Maintaining a loyal relationship with your lender also plays a significant role in determining the interest rate. If you have borrowed from a specific lender before and have always paid your loans regularly and on time, you may have built a good rapport with them. This rapport would later benefit you because your lender could potentially reduce your interest rate because they know you are a reliable customer. 

Building a reliable relationship with your lender early on is crucial since it will influence whether your lender charges a high or low-interest rate based on your relationship with them.

Debt-to-Income Ratio

The debt-to-income (DTI) ratio is a crucial financial metric that compares an individual's total monthly debt payments to their gross monthly income. Lenders use this ratio to assess a borrower's ability to manage additional debt responsibly and to determine their eligibility for various loan products, including personal loans. 

By maintaining a low DTI ratio (ideally 30% or below) through wise financial management and minimising debt obligations relative to your income, you can improve your chances of securing more favourable loan terms and interest rates. 

What is Considered a Good Interest Rate for Personal Loans? 

The definition of a good interest rate might change based on the kind of loan, the state of the market, and the financial situation of the borrower. A good interest rate is one that is competitive and beneficial in relation to current market rates, taking into account both the perceived risk to the lender and the borrower's creditworthiness.

In personal loans, interest rates may vary based on the borrower’s credit score, their income and the lender’s policies. 

Annual Percentage Rate (APR): How is it Different from Interest Rate?

The interest rate represents the fee charged by the lender for the use of their funds and is applied over a specific period, typically annually. Interest rates can be fixed or variable and are a fundamental component of any loan or credit agreement. 

For example, if you borrow INR 10,000 at an annual interest rate of 5%, you would pay INR 500 in interest per year.

The annual percentage rate on the other hand, is a broader measure that encompasses not only the interest rate but also other fees and charges associated with borrowing money from a lender. 

For example, if you borrow INR 10,000 at an annual interest rate of 5% and have to pay an additional INR 500 for other fees like origination fees, etc. your APR would be slightly higher than your interest rate in order to reflect the total cost of borrowing. 

Annual Percentage Rate Calculation

The APR is calculated using a specific formula that considers the interest rate, any fees charged by the lender (origination fees, processing fees, etc.), and the loan term. It essentially expresses the total cost of borrowing as a yearly percentage of the loan amount.

How to Ensure a Good Interest Rate on your Personal Loan

Here are 3 primary ways to ensure good personal loan interest rates:

1. Maintaining a Good Credit Score

Credit scores can directly influence personal loan interest rates borrowers are offered by lenders. Generally, higher credit scores translate to lower interest rates (subject to other eligibility criteria), while lower credit scores result in higher interest rates. 

Lenders often utilise tiered structures based on interest rates to accommodate borrowers with varying credit profiles. These structures typically consist of multiple tiers, each tier corresponding to a specific range of credit scores.

  • Tier 1 (Excellent Credit): Typically scores of 750 and above are placed in the top tier. They reflect strong creditworthiness and low risk of default.
  • Tier 2 (Good Credit): Ranging from 700 to 749, fall into the second tier which allows the borrower to enjoy relatively favourable interest rates compared to lower tiers.
  • Tier 3 (Fair Credit): Ranging from 650 to 699, occupy the third tier. Borrowers belonging to this tier may face slightly higher interest rates compared to higher tiers, reflecting a moderate level of risk to lenders.
  • Tier 4 (Poor Credit): A credit score below 650 is placed in the bottom tier. They may encounter significantly higher interest rates or may even struggle to qualify for certain loan products altogether due to the heightened risk they present to lenders.

The tiers may differ as per the scoring model used and the policy of lenders at the time of loan application. By maintaining good credit, more favourable financial options can be made available to you.  

Must Read:  Tips To Get An Excellent CIBIL/Credit Score 900

2. Comparing Rates from Various Lenders

When seeking any kind of loan, shopping around for lenders is a crucial step in securing favourable terms and maximising your borrowing potential. By exploring multiple options, comparing interest rates and terms, and negotiating with lenders, you can make informed decisions that align with your financial goals.

3. Strengthening your Financial Profile

Having a strong financial profile is an essential step to achieving your financial goals and securing favourable loan terms. By focusing on key areas such as managing your debt-to-income ratio, and establishing employment stability, you can enhance your financial standing and position yourself for greater financial success. 

In order to maintain a low DTI ratio, first focus on paying off existing debts that you may owe. Try to boost your earnings through salary negotiations or freelance work. This helps in lowering your DTI ratio and improving your financial profile.

Must Read:  Factors that Affect Your Personal Loan Interest Rates

Conclusion

In order to secure favourable terms in your personal loans such as low-interest rates, you have to be financially responsible and make smarter decisions so as to avoid lowering your credit score. Having a good understanding of the factors influencing interest rates, such as credit score, employment stability, and debt-to-income ratio, will help you to navigate the borrowing process effectively. 

If you’re looking to apply for a personal loan, SMFG India Credit offers personal loans with attractive features to meet diverse financial needs. You can avail of loans amounting up to INR 25 lakhs* and personal loan interest rates starting as low as 11.99% per annum*. 

Apply online from the comfort of your home or visit your nearest branch to find out how we can help meet your financial goals. 

* Please note that this article is for your knowledge only. Loans are disbursed at the sole discretion of SMFG India Credit. Final approval, loan terms, disbursal process, foreclosure charges and foreclosure process will be subject to SMFG India Credit's policy at the time of loan application. If you wish to know more about our products and services, please contact us

FAQs

What factors determine the interest rate on a personal loan?

The interest rate on a personal loan is influenced by factors such as your credit score, employment history, debt-to-income ratio, loan amount, loan term, and prevailing market conditions.

How can I improve my chances of securing a low interest rate on a personal loan?

To improve your chances of securing a low-interest rate, focus on maintaining a good credit score, demonstrating stable employment, managing your debt responsibly, comparing rates from multiple lenders, and negotiating terms effectively.

What is the difference between a nominal interest rate and APR on a personal loan?

The nominal interest rate represents the cost of borrowing funds, while the Annual Percentage Rate (APR) includes additional fees and charges associated with borrowing. APR provides a more comprehensive view of the total cost of borrowing by standardising all costs on an annual basis.

How does my credit score affect the interest rate on a personal loan?

Your credit score is a key determinant of the interest rate you're offered on a personal loan. Generally, higher credit scores are associated with lower interest rates, while lower credit scores result in higher interest rates to compensate for the lender's increased risk.

What should I consider when comparing personal loan offers from different lenders?

When comparing personal loan offers, consider factors such as interest rates, loan terms, fees, repayment flexibility, customer service reputation, and the lender's eligibility criteria. Evaluating these factors can help you choose the loan offer that best suits your financial needs and preferences.

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