When taking a
personal loan, one of the most important factors is to understand the interest
rate. It directly affects the total repayment amount over the loan tenure. Even
a slight difference in the rate can significantly affect your monthly
instalments and the overall cost of the loan. Whether you are borrowing for a
medical emergency, home renovation, wedding, or education, understanding how
personal loan interest rates work helps you make informed financial decisions.
This article explains everything you need to know about personal loan interest
rates.
What is a Personal Loan
Interest Rate?
The interest rate
of the personal loan is the rate a lender levies on the amount you borrow. It
is what you pay for borrowing funds. Lenders apply these interest rates to earn
income on the funds they provide to borrowers. The rate is referred to as an
Annual Percentage Rate (APR). There are two categories of interest rates, i.e.:
- Fixed Interest Rate: The fixed interest rate remains constant throughout the loan
tenure. Here, your Equated Monthly Instalments (EMIs) do not change. It
allows you to budget your monthly expenses because you know how much you
must pay.
- Floating Interest Rate: The floating rate fluctuates during the tenure of the loan. It
is based on fluctuations in market conditions or the internal policy of
the lender. In case the interest rates in the market rise, your EMI and
loan interest rate can also rise. If the rates decrease, your EMI can
decrease as well.
How Do Lenders Decide Your Interest Rate?
Lenders look at
various factors before determining the personal loan interest rates. These are:
●
Credit Score: A good credit score typically
results in a lower interest rate. It reflects that you have a stable credit
history and you can repay the loan on time.
●
Income Level: Your average monthly income
helps lenders in assessing your repayment capability for the loan. Candidates
with stable and adequate income can receive a reduced interest rate.
●
Employment Status: Salaried individuals with
stable jobs may receive lower interest rates compared to self-employed
applicants, as their income is consistent.
●
Loan Amount and Tenure: Loans with shorter
repayment periods may have lower interest rates, while longer tenures can
result in slightly higher interest rates.
●
Relationship with the Lender: If you have an
existing account or have previously taken loans and repaid them on time with
the same bank or Non-Banking Financial Company (NBFC), they may offer a more
competitive interest rate.
Why Comparing Interest Rates is Important?
Not every lender
has the same rate of interest rate. Even a slight variation in the rate can
have a huge impact on the total you pay back over the duration of the loan.
Compare the rates of different banks and financial institutions using online
calculators. Instead of choosing the first offer you receive, explore multiple
options to find one that aligns with your repayment capacity and financial
plans.
How to Calculate the Total Cost of a Personal Loan
To understand the
actual cost of your personal loan, it is important to use a personal loan EMI
calculator. This calculator allows you to input basic loan details and
calculate your monthly EMI and the total repayment amount. It helps you plan
your budget effectively before applying for the loan. Here’s the basic formula
used to calculate EMI:
EMI = [P × R × (1 + R)ⁿ] / [(1 + R)ⁿ – 1]
Where:
●
P: Amount of the loan
●
R: Rate of interest per month
●
N: Total number of monthly instalments
This formula can be
manually applied, but many borrowers opt for online EMI calculators because
they are fast, reliable, and convenient.
Other Charges That Affect the Cost
While interest is
the primary cost, several additional charges can increase the overall cost of
your personal loan, such as:
●
Processing Fee: The processing fee is a
one-time payment (typically 1%–2% of the loan amount) that the lender levies to
process your loan application.
●
Prepayment/Foreclosure Charges: Prepayment/
foreclosure charges might be levied by a few lenders if you close the loan
before the end of the tenure.
●
Late Payment Charges: In case you delay
payment of an EMI, the lender might levy late payment charges, which form part
of your total repayment amount.
●
GST and Other Taxes: Goods and Services Tax
(GST) is levied on processing charges, prepayment amounts, and other services
related to the loan.
Conclusion
Understanding
personal loan interest rates enables you to make informed borrowing decisions.
Always review the type of interest rate, whether fixed or floating, and compare
offers from various lenders. Even a slight variation in rates can increase or
reduce your total repayment amount. Use an EMI calculator to plan your monthly
budget and assess the overall loan cost. It is important to consider additional
charges such as processing fees and applicable taxes before applying for a
personal loan.