4 factors that affect your personal loan rate
When you apply for a personal loan, you will find out if you are eligible for a loan and what rate lenders will charge you.
Obtaining loan approval is of course important, but the interest rate offered is just as important as the loan approval. Because your interest rate determines the cost of your loan. If a lender is giving you a loan, but only at a very high interest rate, it may not make sense to move on.
Since your interest rate determines the cost of your borrowing, it is helpful to know what lenders are considering when deciding on an interest rate. There are four key factors that will affect your personal loan rate, many of which you can control if you want to qualify for a loan at the cheapest rate. Here is what they are.
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Your creditworthiness is one of the most important factors that lenders consider. It’s a three-digit score on a scale of 300 to 850, with scores above 670 generally considered good or excellent credit.
If you have a very low credit score, you will likely be denied credit. But if your score is bad or fair, it is possible that lenders will lend you a loan, albeit at a very high interest rate. If so, before applying for a loan or applying to a signer with a higher credit score, consider building a loan quickly so that your interest costs are more affordable.
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A co-signer would have to agree to share legal responsibility for the payment so that your lender could try to collect from them if you fail to pay. It is a great responsibility to be a signatory, but lenders will also consider their references so that you can lower your interest rate when someone with good credit is ready to vouch for you.
If you need help, check out our guide to rebuilding your credit for tips on how to improve your credit score.
2. Amount borrowed
It also matters how much personal loan you want. Because lenders actually take your desired loan amount into account when setting your interest rate. The reason for this is simple: the more money you ask, the greater the risk the lender will take in giving it to you.
Larger loans are riskier for several reasons. First, if you don’t pay, the lender has more money. Second, if you make a larger financial commitment, there is a greater chance that you will fail to meet it.
If you need to borrow a certain amount to meet your goal, there is not much you can do about the fact that you may have to pay a higher interest rate because of your high credit balance. However, you should try to borrow as little as possible to meet your goals.
3. Deadline for repayment
Most lenders give you a choice of how long you want to repay your loan. For example, you can choose between a three-year and a five-year payout period. If you choose the shorter term, chances are you will be offered a lower interest rate than a longer term loan.
It does this for the same reason that in order to borrow more, you pay higher interest. Lenders find it riskier to extend a loan over a shorter period of time than it is for a shorter period of time. This makes sense because the more time it takes to repay your loan in full, the more time there will be for a mistake that affects your solvency.
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Choosing the shortest possible repayment period can actually help you save on interest by getting a reduced interest rate and by making sure you don’t pay interest for this long. The big downside, of course, is that every monthly payment gets higher as you shorten your withdrawal time. So don’t choose a repayment term that is so short that you can’t afford the payments.
Read our guide on the advantages and disadvantages of longer terms so that you can decide how long you want to pay off your personal loan.
Your income can also affect the interest rate the lender charges you. In particular, lenders look at income in relation to debt.
If you have a high income and don’t have many other obligations, you may be offered a lower interest rate as you are less likely to be unable to repay your loan. Again, lenders set your interest rate based on the perceived risk.
On the other hand, if your income is quite low and your payments could be difficult to make – especially if you already have a lot of debt – then you are likely only being offered a high interest loan if you have been offered one.
While there isn’t necessarily much you can do to control your income, you should try to avoid changing jobs knowing you will soon be applying for a personal loan. That’s because a longer income history shows more stability and is preferred by most lenders.
By trying to keep your source of income stable, borrowing the smallest amount possible, choosing the shortest repayment term you can afford, and aiming to improve your credit score before you apply, you should be able to apply for a personal loan to qualify with a good interest rate – or better.