DYK: How interest rate is calculated on your personal loan

Hemant Mishra/Mint

Personal loans from the same bank can be offered at different rates to different customers. This is because banks determine interest rates based on the individual’s profile and other details. Here is how it works.

What is a personal loan?

Personal loans are unsecured loans. This means that you don’t have to keep any collateral with the financial institution that you borrow from. Unsecured loans are usually more expensive compared with secured ones because banks don’t have any collateral which they can pledge in case you default. So, a personal loan will be more expensive than a home loan.

According to data from Deal4loans.com, personal loan interest rates are currently between 12.5% and 21% per year. The range is wide; in fact, a bank that offers a rate of 13.75% per annum to one customer can also offer 20% on a personal loan to another.

The difference is due to the various factors that come into play when banks decide the interest rate for you.

Higher income, lower rate

If your income is less than Rs. 35,000 per month, most banks charge you an interest rate of 16-20% per annum. But if your monthly income is above, say, Rs. 75,000, you may get a loan at 14.25-16%. If the income is over Rs. 1.5-2 lakh per month, banks will be willing to give you a personal loan at 12.5% per annum.

Kind of employer

Apart from income, where you work is also important. If, along with an income

on the lower side, say, Rs. 75,000 per month, you also work in a small company, you will find yourself paying at the higher end of the interest rate bracket. If you work for a company that is listed by the bank as a priority company, you may get a personal loan at 13.5-13.99% per annum. This is because banks believe that if you are working for a bigger company, your chances of repaying the loan are higher.

Credit history

When you apply for a loan, during the processing stage, the lenders look at your credit score. The credit score is provided by various credit bureau agencies. Credit score is a number based on your credit report, which is a summary of your past and current borrowings and your repayment history. If you have been regular with your loan repayments, your credit score is likely to be higher. Banks use this score to assess your repayment capacity and the chances of you defaulting on the loan.

What should you do?

Apart from the factors mentioned above, your ability to negotiate and your relationship with the bank also come into play. Remember that almost all the banks charge a processing fee between 0.5% and 2% of the loan amount, and a prepayment charge of 2-5% of the outstanding loan amount. So, if you see your friend getting a cheaper personal loan from the same bank as you, don’t be upset. Just go back and check your credit report. If it’s in a good shape, use it to negotiate.

Source: www.livemint.com

Category: Credit

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