Factors that determine your loan interest rates

Factors that determine your loan interest rates

We often receive emails and messages stating that we are pre-qualified for personal or business loans at affordable rates. Even when you go to a lender for a loan, the interest rate offered to you may be different from the rate offered to your spouse. So how do lenders determine the applicable interest rate for each person and why does it vary? In this article, we will discuss the factors that lenders consider when determining interest rates for loans. 

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Common factors that determine interest rate on the loan

Here are some common factors that lenders review when calculating the applicable interest rate on a loan:

  1. Credit report and credit score of the applicant 

When you apply for a loan, the lender will first pull your credit report and credit score. These scores are an estimate of your creditworthiness and are calculated based on factors such as previous credit history, repayment history, credit card usage, income level, etc. If your credit score is 750 or higher, you have a higher credit score and can get a loan at a reasonable interest rate. On the other hand, if your credit score is poor, you will get a loan at a higher rate even if you have enough funds to repay the loan. 

  1. Age of the applicant 

The borrower's age is another factor considered in determining the interest rate. A younger person with a sound repayment capacity tends to get a loan at a lower interest rate. Similarly, a person who is closer to retirement age will get a loan at a higher interest rate. 

  1. Financial profile 

The financial profile of the person includes their income level, existing financial obligations, and monthly expenses. These parameters help lenders understand the repayment capacity of the person. Therefore, a person with a higher income and fewer or no existing loan commitments will get a loan at a lower rate compared to a person who already has a loan and is seeking another. 

  1. Employment status

Lenders prefer borrowers who have stable and regular employment. The stability in employment status assures the viability of the loan and hence, a lower interest rate compared to a person with seasonal or uncertain employment. Self-employed individuals with stable and regular business income can also get loans at affordable rates, but the interest rates may be slightly higher than those offered to salaried individuals. 

  1. Type of loan and loan size 

Lenders offer multiple loan products, such as personal loans, home loans, business loans, vehicle loans, education loans, etc. Each loan product is designed to meet specific requirements, and therefore, the broad interest rate range for each loan product is different. Additionally, the loan amount sought by the borrower also contributes to the final interest rate offered by the lender. Home loans, for example, are typically large loans but are considered less risky compared to personal loans, resulting in a higher interest rate for personal loans. 

  1. Association with the lender 

Many banks offer concessions in the interest rate if the borrower already has an association with the bank. This association can be in the form of having a basic savings account or fixed deposit with the bank, or already having another loan with the bank. Therefore, applicants often consider applying for a loan with their primary bank as it may reduce their interest cost by about 1%. 

  1. Downpayment (if any) 

Many loans, such as home loans or vehicle loans, require the borrower to make a downpayment, which is a portion of the asset's cost (usually between 10% to 25%). Borrowers also have the option of giving a higher down payment than the minimum required by the lender. If the borrower chooses this option and provides a higher downpayment, it reduces the overall loan amount and ultimately the interest rate as well. 

  1. Collateral 

The interest rates also depend on whether the loan is secured or unsecured. An unsecured loan has a higher risk for the lender, which is compensated by a higher interest rate. In the case of a secured loan, lenders have the option to reduce their loss by liquidating the collateral, resulting in a slightly lower interest rate. 

  1. Tenure 

The tenure of the loan is another important factor in determining the interest rate. The interest rates for long-term loans, such as home loans, are lower compared to short-term loans, such as personal loans or credit card loans. 

  1. Co-borrowers (if any) 

Most big-ticket loans, such as home loans, allow applicants to apply for a loan jointly with their spouse or another family member. In such cases, the credit score of the co-borrower also impacts the final interest rate offered on the loan.

  1. Current economic status 

The interest rate on loans is also impacted by macroeconomic factors such as inflation and recession. When inflation is high, central banks usually increase their lending rates, which trickles down to the interest rates for retail loans. On the other hand, in a growing or recovering economy, interest rates tend to be lower to encourage consumer borrowing. 

Conclusion 

When considering a loan, the interest cost is one of the prime factors to consider. Other factors that affect interest rates include the gender of the applicant (women may receive slight concessions in home loans), geographic and demographic factors, and lenders' policies. It is always better to consider all available options and select the one that offers the most affordable interest rate on a loan. 

FAQs 

Where can I find my credit score?

You can find your credit score in the credit report issued by credit rating agencies.

How does non-repayment of a previous loan affect my future borrowing capacity?

If you have defaulted on repaying a previous loan, the default will be reflected on your credit report for a period of 7 years. This impacts your future borrowing capabilities, and the interest cost for future loans will always be higher.

Can I take more than one loan at a time, and will the interest cost increase for the second loan?

Yes, if you meet the necessary parameters set by the lender, you can avail of more than one loan at a time. However, the interest cost for the second loan will be slightly higher as the risk assumed by the lender increases.

Do pre-qualified loans offer lower interest rates?

Pre-qualified loans do not always offer optimum interest rates. It is always better to consider all available options and select one that offers the most affordable interest rate on a loan.

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