A personal loan is a catchall financial instrument that can be used for just about anything. Whether facing an unexpected medical bill, a bout of unemployment, or other unforeseen budgetary bumps in the road, this loan can tap into cash fairly easily.
Personal loans are very flexible and can be obtained by borrowers with a wide range of credit scores—although the interest rates will be more expensive if your credit score is lower. Apart from your credit scores, several other factors will determine the interest rate you’ll pay on a personal loan. Here’s a summary of what you can look forward to.
How Do Personal Loan Interest Rates Work?
Let’s start by reviewing what a personal loan is: It is generally an installment loan that is not secured by collateral and offers cash that can be spent on all sorts of financial purposes, from debt consolidation to paying for a home repair. A credit card, by contrast, is a type of revolving debt that you can spend and repay as you see fit. A personal loan, in contrast, makes a single large sum of money available to you, which you repay with scheduled monthly payments over time.
All but the rarest personal loans are unsecured, with no collateral to secure them—not so a secured loan, such as a mortgage or auto loan. Secured loans are safer for lenders since if the borrower defaults on repayments, the lender can repossess the collateral that was taken to secure the loan. This is one of the reasons why interest rates are generally lower for secured loans. The rate of interest on any loan impacts the amount you’ll be paying to borrow money during the duration of the loan. Personal loans may have fixed or variable interest rates. With the latter, your rate may change over time.
Also Read : 5 Loans That Gig Workers Can Apply Online
You’ll probably encounter annual percentage rates (APRs) when shopping for personal loans. A loan’s APR is its overall cost, including its interest rate and any other charges and expenses. That includes origination fees, which typically range anywhere from 2% to 5%.
Suppose you’re looking for an $8,000 personal loan with a 9% interest rate and a three-year payback period. You’d pay $1,158.32 in interest over the duration of the loan. Now suppose there’s a 5% origination fee. That adds another $450 to your costs. The APR, which accounts for the other fees levied on the loan, would be 12.78%. This is to say that the APR gives a clearer idea of what the loan will really cost you.
Things That Can Influence APR
The APR of a personal loan can usually be influenced by numerous things. Your credit score usually has the most impact, and can even influence whether you get approved for the loan at all. In general, the better your credit, the greater ease you will have in getting approved and the lower your APR. If you have a lower credit score, this indicates to lenders that you’re a riskier borrower. Lenders tend to counter this increased risk by charging higher interest rates. They may also look at the following as determinants of your interest rate:
- Income: Your lender would like to know that you can pay your monthly loan. If you have irregular income, it may lead to a higher APR. Income is not considered in your credit scores, nor is it reported on your credit reports, but your lender might request it as part of the application process.
- Debt profile: The majority of lenders will estimate how much of your monthly income is already dedicated to debt payments. This figure is your debt-to-income ratio and serves to explain your capability to repay the loan.
- Loan size: Because your interest rate is quoted as a percentage of your loan, you will pay more if you have a bigger loan. The size of the loan that you have to borrow might not be up to you, but it’s worth thinking about as it will affect your overall expenses. If at all possible, don’t borrow more than you really need to.
- Repayment term: Opting for a shorter repayment term will result in a higher monthly payment but it can help reduce your total interest over the long term.
What Is the Average Personal Loan Interest Rate?
Each lender is unique, and good to average personal loan interest rates will differ. To be sure, the average two-year personal loan APR is 9.58%, based on the latest data from the Federal Reserve. That might sound high, but credit cards tend to be much more expensive. The average credit card APR is currently 16.3%, according to this writing.
Suppose you want to borrow $5,000 and repay it in two years. This is how the figures might break down if you borrowed on a credit card vs. a personal loan.
Despite factoring in a possible origination fee, the personal loan would still be the cheapest way to go in the long term.
How to Compare Personal Loans
Aside from the APR, you’ll also want to consider whether you can afford to make your monthly payment. Can your budget handle that expense without affecting your quality of life? Try to make every payment on time, but it’s a good idea to know how late fees are calculated just in case you do miss a payment. Pay late and it can have a long-term impact on your credit and future ability to borrow. Missing a payment can lower your credit score and remain on your credit report for seven years.
Assuming you can afford the monthly payment, it’s always a good idea to shop around for rates and terms. Online lenders and credit unions, for instance, have lower APRs than traditional banks. Experian lets you sift through customized loan offers that fit your credit profile. This makes it simple to compare APRs, fees and loan terms.
If you’re not in urgent need of the money, you may also take the time to review your credit report and build up your credit so you can apply for a personal loan. This can qualify you as a better borrower eligible for a lower rate.
The Bottom Line
There are several variables that determine the interest rate you will receive on a personal loan, but your credit is the most important. Experian Boost®ø is an easy tool that may boost your FICO® Score☉ based on Experian data in seconds. It can connect your phone, utility and select streaming service bills directly to your Experian credit report. That way, you can be rewarded for paying these bills on time every month.
