MUMBAI: When you take out a personal loan, you agree to repay the principal amount, plus interest, over a specified period. The interest rate plays a significant role in determining the overall cost of the loan, which can, in turn, influence your spending capacity, savings, and other financial goals. Understanding its impact on your monthly payments and long-term finances is crucial to making informed decisions.
This article explores how personal loan interest rates can affect your finances, the factors that determine these rates, and strategies for securing personal loans with favourable interest rates.
How Personal Loan Interest Rates Can Impact Your Finances
Monthly Payments
A higher interest rate typically leads to higher monthly payments, reducing the amount you may allocate to savings or other financial investments. Conversely, a lower interest rate can result in lower monthly payments, freeing up more of your income for different purposes.
Total Cost of the Loan
A higher interest rate means you'll pay more in interest over time, increasing the total cost of the loan. Conversely, a lower interest rate can reduce the total interest paid over the loan period, which can help you save money in the long term.
Loan Tenure
To accommodate the higher EMIs (Equated Monthly Instalments) that could result from higher interest rates, borrowers may opt for a longer loan tenure. While this can lower monthly payments, it may also increase the total interest paid over time and extend your financial commitment, potentially delaying future financial goals. On the other hand, choosing a shorter loan tenure can lead to higher monthly EMIs, but it often results in lower overall interest costs and a quicker path to debt freedom. This option can be beneficial for those who want to minimize their total interest payments and are in a position to manage the higher monthly expenses. Ultimately, the choice between a longer or shorter tenure should align with your financial situation and long-term goals.
To better understand the relationship between the loan amount, interest rate, and tenure, you can use a personal loan EMI calculator, such as those provided by reputable lenders like SMFG India Credit. By experimenting with different loan amounts, interest rates, and tenures, you can get a clearer picture of their impact on your EMI and the total amount payable.
Important Note: While the interest paid on a loan (determined by the interest rate charged by a lender) is a major component of the loan's total cost, it’s not the only one. Other components, such as contribution to the principal, processing fees and prepayment charges, also impact the loan cost. Additionally, the EMI calculator does not account for any value-added services such as insurance.
What Determines Personal Loan Interest Rates?
Understanding the factors that influence interest rates can lead to more informed borrowing decisions. While your CIBIL score is a fundamental factor—borrowers with scores above 750 are typically favoured for lower personal loan interest rates—several other factors also come into play.
Lenders evaluate multiple criteria, including:
●Age of the Borrower: Lenders usually prefer borrowers to be younger, and not close to their retirement age. This is because younger applicants usually have potential to increase their income and comfortably repay the loan.
●Income Stability and Employment History: Stable income and long-term employment with a reputable organisation are preferable.
●Existing Debt Obligations: High existing debt may result in a higher interest rate or limit the amount you can borrow.
●Loan Amount and Tenure: Larger loan amounts and longer tenures may result in higher interest rates.
●Current regulatory policy and Market Conditions: Lenders can adjust interest rates based on prevailing rates set by regulators and broader economic conditions.
Based on the lender’s policies at the time of your loan application, as well as your requirements and profile, lenders determine the best personal loan rates available to you. This will allow you to plan your monthly budget accordingly, ensuring that you can comfortably manage your EMIs.
Strategies for Securing Personal Loans With Lower Interest Rates
Here are some actionable ways to increase your chances of getting a personal loan with lower interest rates:
1. Maintain a CIBIL Score Above 750
Aim to keep your CIBIL score above 750. Timely payments on credit card dues, EMIs, and utility bills can positively impact your credit score. Regularly review your credit report to catch any discrepancies or errors that could affect your score.
2. Demonstrate Income Stability
Maintaining long-term employment in the same role or industry demonstrates stability—a key factor lenders consider when determining interest rates. List any supplementary income sources, such as freelance work or rental income, to strengthen your application and improve your interest rate options. Keep a record of recent salary statements, as these provide proof of income and may be requested during the application review.
3. Maintain Healthy Financial Ratios
Keep your debt-to-income ratio below 30% to show lenders you have manageable debt levels relative to income. Additionally, maintain your credit utilisation ratio (credit used relative to available limit) at or below 30%, as higher utilisation may signal increased credit dependency.
4. Compare Lender Offerings
Compare different lenders to get a good understanding of the varying rates and terms. Evaluate other associated fees and charges such as processing fees, as these can add to the total cost of the loan. If you already have a strong existing relationship with a lender and a good repayment history, you may get preferential interest rates.
5. Optimise Loan Tenure
Strike a balance between an affordable EMI and the total interest payable over the loan tenure to keep payments manageable. Remember that longer tenures can result in lower monthly payments but higher interest paid, and vice versa.
The Bottom Line
Personal loan interest rates play a crucial role in determining the overall cost of borrowing, impacting both your monthly budget and long-term financial goals. By understanding their effects, you can make informed decisions that support both your immediate needs and future aspirations. To secure loans with favourable interest rates, prioritise healthy financial habits, such as maintaining a strong credit score, limiting credit utilisation, and comparing different lenders to ensure you choose the most suitable loan option.
