Factors that affect the interest rate on your loan

By Guest |  18-09-18 | 

Everybody who applies for loans with a particular lender will not always end up being offered the same rate of interest on their loan. Aditya Kumar, Founder and CEO of Qbera.com explains why.

Personal loans are a form of unsecured credit and attract interest rates in the range between 10.75% and 25% p.a. With a highly competitive market in picture, lenders are often pulled into stiff competition and vie to offer the best rates with a view to attract more customers and augment their market share. As a borrower, you’d certainly want to be offered the lowest rate, won’t you? Well, everybody who applies for loans with a particular lender will not always end up being offered the same rate of interest on their loan.

When you apply for a personal loan with a lender, there are multiple parameters that determine your loan approval and the interest rate you’re offered. Your credit score, repayment history, income, and employment stability are some parameters that have a significant impact on your credit score.

Very interestingly, lenders who advertise offering the best rates in the market do not offer every applicant the same rate. So if you see one lender offering a rate of 10.75% p.a. and another offering a rate of 12% p.a., just because you get approved by the first lender, it doesn’t necessarily mean that you’re going to end up getting your loan at that rate.

So how then is the interest rate determined?

When you choose a particular lender and submit your application, the lender pulls your credit report from the bureau in an act commonly known as the hard pull. Each hard pull leaves an indelible impression on your credit report. More so, too many hard pulls can negatively impact your credit score as it reflects a certain credit-hungry behaviour, increasing the element of risk for lenders to let you borrow.

Financial institutions offering loans have adopted a model known as the risk-based pricing model to determine the cost of borrowing. Through the model, lenders determine the rate of interest as well as a bunch of other charges – this differs from applicant to applicant. According to the risk-based pricing model, lenders calculate the approximate probability of default in the case of borrowers based on essential parameters (credit score, repayment history etc.) and offer them a rate based on that calculation of risk. Meaning, a borrower who has a low credit score and a poor repayment pattern will be offered a high rate of interest to enable the lending institution to cover the element of risk in the event that the borrower will default (the rate is based on the lender’s estimated calculation that the borrower will default).

Having understood this, let’s take a look at some factors that affect your loan interest rate.

  • Credit score

This is the fundamental parameter that determines your eligibility as well as the interest rate that you’re offered on your loan. Going by the risk-based pricing model, if your credit score is good, you can be sure of getting a lower rate of interest on your loan. This is because as per the lender’s estimate of probable default, you are more credit-worthy in comparison to individuals with a low credit score.

  • Repayment history

A good repayment history often works well for applicants seeking loan approval. Sometimes, if an applicant has a good credit score but not a very impressive repayment history (instances of late payments), he/she will often be offered a moderate rate of interest – not too high or not too low.

  • Defaults
Presence of defaults in credit profiles not only prompt higher rates of interest but also lead to rejection. Most lenders that offer personal loans prefer applicants who have no defaults over the last 12 months at least.
  • Employer reputation

Another aspect that impacts interest rates is an employer’s reputation. Applicants employed with big organisations are often offered lower rates. Job stability and timely salaries are aspects that are taken into account in the case of applicants working in reputed organisations.

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