6 primary factors that determine personal loan interest rate

A personal loan is an unsecured sum of money lent by a bank, which must be repaid within a specified timeframe, usually in monthly instalments known as EMIs. While personal loans offer a quick and hassle-free way to meet financial obligations—whether for weddings, higher education, or purchasing a car—the interest rates tend to be higher than those associated with home loans.

The rate you receive largely depends on your eligibility and financial profile. Here are the primary factors that influence personal loan interest rates:

Credit history matters

Your credit history plays a crucial role in determining whether a bank will lend you money. It reflects your past repayment behaviour and is directly linked to your credit score. A good credit history indicates responsible borrowing and timely repayments, making you a more attractive candidate for a loan. As a general rule, the better your credit score, the lower your interest rate is likely to be.

Income is key

A stable and sufficient income is essential for securing a favourable interest rate on a personal loan. Lenders want assurance that you can repay the loan, and a steady job with a reliable income increases their confidence. Maintaining a low debt-to-income ratio—by avoiding multiple loan applications and managing credit card usage—also helps in securing better rates.

“It's important to maintain a low debt-to-income ratio by avoiding multiple loan applications or excessive credit card usage. Additionally, borrowers should ensure they meet the lender's eligibility criteria, such as minimum income and employment stability, and double-check that all required documents are complete and accurate before submission, says Akshay Mehrotra, Co-Founder and CEO, Fibe.”

Employment type matters

The type of employment you have can influence the interest rate on your personal loan. Borrowers with stable government jobs typically receive lower rates due to greater job security. Even within the private sector, the reputation and stability of your employer can make a difference. Lenders are more likely to offer favourable terms to borrowers from reputable companies.

Lender relationship

Your relationship with the bank can also impact the interest rate you receive. A loyal customer with a clean repayment history may find they have leverage to negotiate better terms. If you have previously borrowed from the bank and have a record of timely repayments, the lender may be more inclined to offer you a lower interest rate.

Repayment record rules

Your repayment history is a significant factor in determining your loan eligibility and interest rate. A clean record free of defaults can speed up the approval process and may lead to more favourable loan terms. Lenders closely monitor repayment behaviours, and a solid history can work in your favour.

Additional factors

While the above are primary considerations, other elements may also influence interest rates, including loan amount, loan tenure, and market conditions. Additionally, lenders may have their own specific criteria that could affect the rate you are offered.

Conclusion

Personal loans can provide financial relief, but they often come with higher interest rates. It’s essential to understand the factors that influence these rates to make informed decisions. Always research and clarify the terms before applying for a loan, ensuring that you are aware of the potential costs involved.

By taking the time to understand these factors, you can better position yourself for a favourable loan experience and achieve your financial goals with confidence.