How is a personal loan interest rate calculated? Know here
Personal loans are unsecured loans provided by financial institutions to meet the financial needs of individuals. The interest rate for personal loans is usually higher than those of other types of loans as they are unsecured. The interest rate for personal loans is calculated based on several factors, such as the borrower’s credit score, employment history, and loan amount.
Calculation of personal loan interest rate
The formula for personal loan interest rate calculation is:
Interest Payable = Principal x Rate of Interest x Tenure
Principal refers to the loan amount borrowed
Rate of Interest refers to the interest rate charged by the lender
Tenure refers to the duration for which the loan is borrowed
The interest rate can be calculated in two ways:
Flat interest rate: In this method, the interest rate is calculated on the entire loan amount and remains constant throughout the loan tenure.
Reducing balance interest rate: In this method, the interest rate is calculated on the outstanding loan amount, which reduces with each EMI payment.
Factors that affect personal loan interest rates
Credit score: A credit score is a representation of an individual’s creditworthiness. It is calculated based on credit history, repayment behavior, credit utilization, etc. Most lenders prefer a credit score of 750 or above to approve a personal loan application with the best possible interest rates.
Income: An individual’s incomes significantly determine the interest rate on a personal loan. The higher the income, the lower the interest rate on the personal loan for many lenders. Lenders prefer borrowers with a stable and regular source of income so that there is no risk of defaulting.
Employment history: A stable employment history indicates a regular source of income and increases the chances of timely repayment. Borrowers with a stable employment history are generally offered a lower interest rate on personal loans, among other factors being considered by the lender.
Loan amount: The loan amount also affects the interest rate on a personal loan. Generally, lenders tend to offer a lower interest rate on a higher loan amount, but this varies across lenders. Moreover, it is important to note that borrowing more than required can lead to a higher interest cost and repayment burden.
Loan tenure: Typically, lenders offer a lower interest rate on shorter loan tenure. However, a shorter loan tenure can lead to higher monthly installments and increase the overall cost of borrowing.
It is crucial to determine the actual borrowing costs by calculating the interest to be paid before applying for a loan. Use the appropriate formula or an online personal loan calculator to calculate the amount. It is also important to compare the interest rates offered by different lenders before applying for a personal loan to get the best deal.