Did You Know?
We serve loans, the best way you can borrow
Anyone in the financial industry already knows how rapidly the interest rates on savings and loans keep changing. It might be because of various parameters such as monetary policies by the RBI, inflation, economic development, etc. However, regardless of the reason behind interest rate fluctuations, there are certain things you must understand. This post helps you evaluate the basics of interest rates, how interest rates work, and important factors affecting interest rates of personal loans.
Interest rates are the “cost of money.” Simply put, it’s an amount a financial bank/lender/financial institute charges the borrower. It is calculated in percentages depending on the principal or the number of loans. An interest rate on a loan comes annually and is denoted as APR or annual percentage rate.
For borrowers, it’s compensation for using the money lent. Banks and financial institutes also pay an interest rate as a percentage to people who save money in their accounts. It’s a type of reward given by banks or financial institutes. The best example of such a reward is the fixed deposit, or FD.
Two categories of interest rates are applied to personal loans. They are-
The interest rate in this case is unchanged throughout your loan tenure. It offers predictability & stability as your EMI amount stays the same each month. The option is preferred by many who value consistent repayment schedules. People who want to avoid fluctuations caused by market conditions can consider this.
2. Floating Interest Rate
The interest rate in this case is based on your lender's benchmark or market trends. It may start at a lower rate but may increase over time. It entirely depends on the economic conditions. You need to be prepared for changes in your monthly EMIs during repayment if you opt for this type of interest rate.
When you borrow an amount of money, there are some reasons behind your decision. Say, for instance, that you want to start a business or buy your dream home. In such circumstances, when you visit the bank or financial institute for a loan, your lender will charge a certain interest rate.
The lender calculates the rate of interest using either of these methods – compound interest or simple interest. Compound interest is based on the principal amount. It’s the accumulated interest of past periods and is called “interest on interest.”
Lenders have to pay higher interest rates when the lender follows the compound interest method. The interest here tends to be higher than the simple interest method. The interest gets charged on the principal monthly, including the accrued interest from past months. The method to calculate compound interest is as follows:
Compound Interest = p x [(1 + interest rate) n − 1]Here, p is the principal, while n is the total number of compounding periods.
On the other hand, simple interest is calculated on the loan's original amount, i.e., the principal amount.
Suppose you apply for a Rs. 50,000 loan from a lending institute or bank. The loan agreement includes 3% simple interest. So, the interest rate is Rs. 1500. The bank or financial institute calculates the simple interest as:
Simple Interest = principal x rate of interest x timeThat’s how the interest rate for loans works.
The rate of interest determines the amount of money you receive during the life of your loan. The institute or bank charges higher rates if the risk of default is higher. Suppose you have bad credit and you wish to apply for a loan.
In such circumstances, the lender views your risks differently and charges a higher interest rate. Interest rates may vary based on the loan type. Mortgages may use simple interest, while some loans opt for compound interest.
Now, let’s come to the discussion of saving money and getting a percentage as a reward.
Most people prefer saving money in financial institutions or banks. When you save a certain amount of money in a bank or financial institute, you allow them to use your money. So, as a depositor, you receive a certain amount of money at an interest rate as compensation.
The bank rewards you with this amount because you allow it to use your money to fund investments and loans. The rate gets charged based on the total amount of money they save.
The concept of interest rates is a huge topic of discussion in finance. If you wish to learn about parameters that affect interest rates in India, the following points are categorized based on two types: First, let’s discuss the factors that affect interest rates on loans. Then, you can discover the parameters that affect interest rates in general.
What are the four factors determining interest rates on loans? Let’s evaluate them one by one:
NBFCs and banks hesitate to approve loan applications of defaulters. The best they can do is approve the loan at a higher interest rate. Now, who is a defaulter? In simple language, a defaulter is someone who’s not consistent with their repayment abilities and time.
Failing to repay debts can result in loan defaults. So, if you have been in default on your CIBIL report for more than five consecutive years, you may have fewer chances to get your loan application approved or may be charged a higher rate of interest.
The loan term is the length of your loan and is one of the determinants of interest rate fluctuation. The term may also influence the rate of interest. Usually, banks and financial institutes offer higher interest rates to an eligible candidate who opts for a longer loan period.
Suppose you want to apply for a personal loan. In such cases, your income might be a prioritised parameter that the lending institute determines. Financial institutions evaluate your employment stability and income.
They determine the repayment capacity by assessing your income details. You may get a better interest rate with a stable monthly income. A consistent job history may also increase the interest rates.
Your CIBIL score may range between 300 and 900. The higher the amount, the more seamless it is to get better interest rates. Usually, a candidate with a 740 or higher credit score is eligible to get the best interest rates from the lending institute or bank. You can improve your credit score by frequently checking it and discovering ways to improve it.
The following are the factors that affect interest rates in general:
Government policies have an influential impact on the changing rate of interest. When the central government wishes to make money, it lowers the interest rate. In general, the Reserve Bank of India uses reverse repo rates and other rates to improve lending and borrowing rates in India. The changes may have a ripple effect, affecting other rates of interest like credit card rates, mortgages, and more.
Corporations fulfill their funding needs by borrowing from lending institutes or choosing funds from stocks. Suppose the markets are bullish. In such cases, companies might prefer to choose equity expansion.
Nonetheless, these corporations prefer to borrow from financial institutes during any poor market cycle. The increase in borrowing demand affects the interest rate.
Macroeconomic situations may impact interest rates. Some of the factors that affect interest rates based on macroeconomic scenarios include the following:
Lenders would automatically increase interest rates with higher credit demand. That offers more opportunities for lenders to make higher returns. Similarly, when there’s a decrease in borrowing habits, lenders reduce the rates.
A fiscal deficit occurs if the government spends more money than the amount collected from revenues and taxes. The government manages this deficit by borrowing from the market. The rate of interest will rise if the government borrows money to pay budget deficits.
Inflation is the increase in prices or the cost of living in an economy. So, there would be higher interest rates due to the rise in prices of goods and demand. On the contrary, deflation reduces interest rates since the demand for money falls.
Securing an instant personal loan rate requires smart financial planning. Here are some-
Paying your dues timely helps improve your credit score. So does reducing outstanding debt. A higher score ensures better terms from lenders. Lenders consider you reliable, so they offer lower interest rates on personal loans.
2. Lower Your DTI Ratio
Your DTI Ratio determines how much of your income is required for repaying loans. A lower ratio means better financial stability. It assures lenders that you can manage additional repayments. This also improves your chances of securing attractive loan terms.
3. Opt for a Shorter Loan Tenure
Longer durations reduce monthly installments. However, they usually increase overall interest costs. Selecting a shorter tenure may raise EMIs slightly. It may save you money on interest in the long run. This way, you can make your loan affordable.
4. Ensure a Steady Income
Lenders favour applicants with a monthly income & stable employment. Demonstrating job security reassures them of your loan repayment capacity. This helps you qualify for better personal loan interest rates alongside smoother loan approval.
So, this post has compiled everything about interest rates in India. You now understand the meaning of interest rates and how it works in India. You have also read about the most important factors that affect interest rates in India.
The interest rate for a personal loan depends on your lender's preferences. It is based on your income, repayment capacity, credit score. Personal loan in India ranges from 12%-36% annually. You need to have a strong credit profile as well as a stable income to generally qualify for lower rates. People with weaker financial records may get higher rates. So, you must always compare offers across lenders before applying. This helps you ensure affordable deals.
Calculating the personal loan interest rate is easy. You need to follow this standard Personal Loan EMI Calculator for interest rate-
EMI = [P × r × (1+r)^n] ÷ [(1+r)^n – 1]Where,
p = Principal
r = Monthly Interest Rate
n = Tenure in Months
The formula for calculating personal loan interest depends on whether it is a flat rate or a reducing balance rate. Interest, in most cases, is calculated on the outstanding principal every month. This helps you determine monthly payments depending on your loan amount, rate, as tenure.
A personal loan interest rate is the total percentage charged upon your borrowed amount by the lender. On the other hand, EMI is Equated Monthly Installment. It is the total monthly payment you make. The latter includes both principal repayment as well as applicable interest portion. On the other hand, the interest rates indicate the cost of borrowing. Note that EMIs reflect your repayment schedule. So, a lower interest rate results in small EMIs.
Your credit score is an important aspect that every lender determines before approving your personal loan with a decent interest rate. A high score shows that you are financially responsible. It means you have a strong repayment record. This helps you secure lower interest rates. On the other hand, a low score signals higher risk for lenders. This may result in higher rates or loan rejection as well. All in all, maintaining a good credit score improves your affordability while approving your loan application.
Lenders can review the repayment history before they set up an interest rate on any loan. You will be seen as a reliable borrower in their eyes if you pay credit bills & EMIs on time. That makes lenders likely to offer better terms alongside lower interest rates. Nonetheless, frequent late payments or defaults may damage your creditworthiness.
The answer is yes, income level determines the interest rate offered on a personal loan. Lenders prefer applicants with stable income as it reduces default risks. Note that a strong income profile results in greater rates. On the other hand, a lower income may mean higher charges. Proof of employment as well as financial stability improves your personal loan eligibility. A higher income reassures lenders that you are capable of repaying the loan without default. This helps you get better loan terms.
The loan amount you apply for may directly impact the interest rate. Note that small loans can bring higher rates as the lenders earn less. Larger loans on the other hand may qualify for lower rates when you have a strong credit profile. The higher loan amounts also mean stricter eligibility checks. This may include your credit score or income (and even repayment history). You should request only the amount that you can pay. This way, you can secure a favourable interest.
Download our personal loan app to apply for a personal loan. Get up to 2Lakhs* as a personal loan. Download Now!
Sign into avail a personal loan up to ₹ 2,50,000
Unifinz Capital India Limited is a Non Banking Finance Company (NBFC) registered with the Reserve Bank of India (RBI). lendingplate is the brand name under which the company conducts its lending operations and specialises in meeting customer’s instant financial needs.
RBI CMS
RBI Sachet
