In simple words, the personal loan interest rate is the amount that a borrower must pay to a banking organization for using a financial product for a certain period. For example- if you take a million rupees from a bank, you need to return a million of the principal debt and a fee for using the loan — the interest rate determines just its size.
So, it is appropriate to say that the interest rate is one of the main parameters borrowers pay attention to while choosing a personal loan. Changes in interest rates in various segments of the financial market affect the willingness to borrow the loan. Let’s have a candid look and discuss factors that can affect your personal loan interest rate.
A Brief Introduction To Types of Interest Rates
Interest rates on personal loans can be standard or real (effective interest rates). A nominal rate is a rate that is mentioned in the loan agreement. The effective rate is the actual cost of the service for the loan, which the borrower pays using a personal loan. It includes all commission and insurance premiums. When comparing loan offers from different banks, pay special attention to the advertised interest rate on loans and the real ones. Before signing the loan agreement, you have the right to calculate the interest rate. If banks advertise that they have canceled commissions, carefully study their offers before entering into a loan agreement. Many banks maintain a high level of silence on the commission for cash withdrawals. So, you need to be careful, make an inquiry about it and make an appropriate decision accordingly.
Factors That Affect The Interest Rates of Loans:
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RBI’s Policy
It is one of the main factors that determine the interest rates of loans. Monetary policy decisions made by the Reserve Bank of India translate into changes in interest rates in all financial market segments. So, a change in the vital interest rates almost instantly leads to a similar change in the loan market. Depending on the availability of liquidity, inflation, and other factors, the Reserve Bank of India changes the key interest rates and tries to control the money flow in the market. The current RBI interest rate is 4.0%. Any fluctuation in this interest rate affects the overall loan market.
Also Check: Latest Personal Loan Interest Rates of All Banks and NBFCs in India
Important to Know: Why does the RBI change its Interest Rates?
Consistently low inflation is an essential condition for the normal development of any economy. When prices rise slowly, companies can make plans for several years ahead and mull over long-term investments for their development. Ordinary people have the same saga. They save money for the future and don’t care about currency devaluation-thanks to RBI’s changes in interest rates. Thus, a reasonable monetary policy creates an optimal condition for the healthy development of an economy.
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Bank’s Credit Policy
The credit policy is a set of programs and actions to provide loans to legal entities and individuals under certain conditions. It is based on a risk-return ratio acceptable for a financial institution. External macroeconomic and internal microeconomic factors determine the bank’s credit policy. Macroeconomic components are the country’s general economic situation, such as the inflation and interest rates, the state of the national currency, and competition in the banking sector.
Banks can’t control these factors independently. In addition, legal issues, the size of mandatory reserves, and regulatory authorities can significantly impact the credit policy of the banking system. Microeconomic factors affecting credit policy include the resource base, the cost of attracting monetary resources, the customer base, the specialization of the bank, and the liquidity of the credit institution. Always keep in mind that you have no role in the bank’s credit policy. That is why you must choose the interest rates of different banks and choose a bank with the lowest possible interest rate.
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Your Income
The borrower’s income is one of the main parameters banks consider when deciding on granting a loan, determining the amount of a possible loan, and calculating the interest rate. Most credit borrowers confirm their income by submitting a personal account statement to the bank. But financial institutions and reputed banks think far more than this.
The financial institutions pay attention to the duration of employment with a particular company or organization and professional relationship (government job, fixed-term contract, full-time job with a company for an extended period, etc.). A long and continuous work with a particular company indicates stable financial flows of the borrower. Therefore, most banks ask you to submit at least six months of work experience certificate and salary statement to process your application for an instant personal loan and determine the interest rate.
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Income Sources
A separate group of banks (business banks) treats individual entrepreneurs and company managers differently when applying for personal loans. They ask borrowers to submit papers related to tax returns, monthly turnover statements, balance sheets, profit and loss statements for the last year, and other documents confirming their financial stability. For such borrowers, the bank sets an increased interest rate on loans. If you have multiple income sources (interest on Bank deposits, rents premises, pension, alimony, dividends, etc.), submit papers to confirm it and negotiate the interest fees with an upper hand. Apart from this, the presence or absence of movable and immovable property positively affects the bank’s decision to issue a loan and reduce the loan’s interest rate.
Always keep in mind that many banks consider the borrower’s income and his family and guarantors if any. While calculating the total income of the borrower’s family, the bank thinks the number of dependents that the borrower has and deducts expenses for the maintenance of these individuals from the borrower’s income. Working family members often act as co-borrowers, which will allow them to combine their income and get a more considerable loan amount (with a low-interest rate) as a result. As a general rule, the loan payment should not exceed half of the borrower’s income. Otherwise, the debt burden on the debtor will be unbearable, which often results in the non-repayment of the borrowed money.
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Your Credit Score
Your credit score is an essential factor that helps banks determine the loan interest rate. In simple words, the credit score is a statement that describes a person’s payment discipline over the past ten years and reflects what loans they took out and paid (or did not pay) and how timely. Banks evaluate the borrower’s credit history strictly and decide whether they have to reject or approve the borrower’s loan application. The rating depends on various parameters: already paid or active loans, delinquencies, debt load, etc. The higher the number of rating points, the more reliable the borrower is considered by banks.
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The Loan Amount And Term
These two significantly impact the loan interest rates. Generally, banks are more interested in issuing a sizeable long-term loan at a lower rate than a small and short-term one. Remember that the interest rate on a long-term loan with liquid collateral will be lower than on a short-term loan without collateral. You must discuss all these factors and choose a personal loan with the lowest possible interest fee.
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Your Age
It is an important parameter used by banks to decide whether to approve a loan and at what rate or reject his application straightaway. In 2019 and 2020, the most active borrowers in India were people aged 30 to 40 years. They accounted for 40% of all debt owed by individuals in the country. Banks love such categories of people as they have a stable income, a steady job, and are more responsible while paying back loans. They also have attractive lending programs for pensioners and old-age people. Despite their age, such people are famous for their financial discipline. So, they get personal loans with a moderate interest fee. On the other hand, young people get personal loans with a higher interest rate in most cases.
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The Ability to Pay and Insurance
If the person who applies for a loan is not a salary client of the bank, then the rate for him, as a rule, will be higher. But a lot will depend on a whole set of factors by which the bank assesses the borrower’s financial circumstances—your ability to pay the loan matters a lot when banks determine interest rates on personal loans. Purchasing insurance (life and health of the borrower) is an additional factor that can lower the loan’s interest rate level. It is important to note that insurance papers are an optional condition. Banks can’t force you to present insurance papers. But they can raise the rate if there is no insurance or if the borrowers refuse insurance.
You must keep in mind that obtaining insurance will not always ultimately reduce the loan rate. This is because the bank still considers a whole set of different borrower parameters, and insurance may not be the most significant of them.
Will Personal Loan Interest Rates Go Up
In India, a large number of people take personal loans to meet various unavoidable financial needs. That is why they keep a close eye on what’s happening in the loan market, what factors affect their eligibility for the loan and prepare accordingly for application. As per industry experts, the personal loan interest rate is likely to increase slightly and stay at 4.75 percent in 2022. It is believed that the Reserve Bank of India will strike rapidly growing inflation by increasing the interest rate. As a result, the central bank will discontinue its accommodative policies that result in easy liquidity conditions.
Concluding Remarks:
The available monthly income and cash reserves prove insufficient to meet an unavoidable financial need in different life situations. That is why they take personal loans. A wide range of factors after the loan interest. You must have a look at these parameters and do the homework before applying for a personal loan online. With a careful approach, you can get a personal loan at a low-interest rate, meet essential needs and bring your financial life back on the right track. Buddy Loan makes it easier to get loans with moderate interest changes with its services. So, it deserves your attention when you apply for a personal loan. Happy Borrowing!
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Frequently Asked Questions
Q. What Are The Three Important Factors That Affect The Interest Rate On The Loan?
A. These essential factors are your income, credit score, and the loan amount you want to get.
Q. What Affects The Cost of A Loan?
A. The entire cost of the loan depends on many factors such as loan amount and term, bank’s reputation, timely or early repayment of the loan, the availability of collateral or guarantor, credit score, overall condition of the market, etc.
