How Interest Rates on Personal Loans are Determined

When it comes to personal loans, it might be confusing as to how different rates can be offered by the same bank. In most cases, it will depend on the consumer in question. This is because a lending institution will use one’s credit profile and other details when determining what interest to charge.

Understanding What a Personal Loan Is

Personal loans, sometimes called signature loans, are basically unsecured loans, which means that the bank you intend to borrow from will not require any type of collateral. In most cases, unsecured loans generally are attached with higher interest charges when compared to secured loans since lenders do not retain any form of security which they can cash in case the borrower defaults. For instance, you will find that a home loan has a much lower interest rate than personal loans just for the simple fact that if a borrower defaults on the payments, then the lender can repossess the property, sell it, and re-coup some or all of the loan amount.

What Is Involved in Determining the Cost of Loans?

The cost-plus pricing model is a rather simple loan pricing method involves making the assumption that the rate of interest charged on any personal loan will be determined by the following components:

  • The funding costs that the financial institution incurred in order to raise the funds for lending, regardless of whether they were obtained from customer deposits or via various money markets.
  • The transactional costs that come with servicing the loan, which may include application and payment process. Other expenses may include bank wages, occupancy expense, and salaries.
  • A risk premium intended to provide the bank with compensation for the degree of default risk that accompanies the loan request.
  • A profit margin for each loan that offers the bank an adequate return on its capital.

In addition, the difference in interest rates charged from person to person when securing such personal loans will depend on another variety of factors that a bank will use to decide how much to set for each individual.

Interest Rates Based Largely on Credit Ratings

When you decide to apply for a personal loan, your potential lenders will start by looking at your credit score during the processing stage. This score is typically provided by the three major credit bureau agencies. Each agency provides the lender with the number between 300-850 obtained using your credit report which lists your past and current borrowings together with your repayment history. For people who make regular and on time payments and do not overuse their available credit, the credit score will more than likely be in the range of 700+. Banks and other financial institutions will use these scores to evaluate your repayment capacity as well as the risk of you defaulting on the loan. Many people also opt for these loans as business loan to start or fund a small business. TI Financial also provides services for good, fair and business loans for bad credit to help people. These are completely different programs.

Employment Status – Effect on Interest Rates

Aside from your income and current credit score, the status of your employment and your place of employment can certainly play a part when trying to secure a personal loan. For example, if your income is below average, you work in a small company, or you are self-employed, you will most likely find yourself paying a higher interest rate. This is because most banks believe that if one is working for a bigger company, their chances of repaying a loan are much higher, while those on the opposite end are more likely to default.

In addition to the aspects mentioned above, your ability to negotiate and the relationship you have with your selected lender will also come into play when trying to secure a personal loan.

Tips and Information

Uses : Knowledge : Secured vs Unsecured