Personal Loan Interest Rates: How Are They Calculated?

Personal loans are close-ended, and the borrower must pay monthly payments until they pay off the full balance. The interest rate on personal loans is a  percentage of the borrowed total. When seeking a loan, the lender quotes an interest rate to the borrower. This interest rate is the annual percentage rate (APR). Several factors go into determining the interest rate, and borrowers must understand how everything works before they pursue a loan. 

What Factors Do Lenders Consider for Personal Loans?

Before banks can give loans, they must borrow the money from customer deposits or other banks. Borrowers typically look for low interest rates when considering the best personal loans in utah. Banks determine a borrower’s interest rate based on the following critical factors. 

The Borrower’s Credit Score

Borrowers with better credit scores tend to get offered the best interest rates with personal loans. Lenders see good credit scores as less of a risk. The bank’s goal is to lend money with as little risk as possible. The greater the risk, the more they will charge in interest. As a part of the borrower’s creditworthiness, lenders may also consider their income and employment status. Borrowers with low income or missed payments can expect higher interest rates. 

The Loan’s Length

Lenders will also consider the loan’s length when deciding on the interest rate. Most lenders prefer long-term loans over short-term ones because they make more money in interest. Banks will almost always offer more favorable interest rates to borrowers pursuing long-term personal loans

The Cost of Borrowing From Another Bank

Many borrowers are surprised banks must borrow money to lend money. Banks lend to one another at a rate based on the federal funds rate. The banks pass this interest rate cost onto borrowers and factor in the other two above to determine the final interest rate for the borrower. 

Lenders Consider Secured and Unsecured Loan Interest Rates Differently

Lenders will also consider whether the loan is secured or unsecured. The vast majority of personal loans are unsecured. An unsecured loan is not backed by any assets owned by the borrower.  Secured loans have collateral, such as a home or car. Lenders will give better interest rates on secured loans because the collateral ensures the loan gets paid by the borrower or the bank takes the collateral. 

How Can Borrowers Get the Best Interest Rates on Personal Loans?

Getting the best interest rate means taking a concerted approach to shopping for personal loans. Even though the APR often rises, there are still opportunities to enjoy savings. Borrowers should consider taking the following steps before searching for a loan. 

  • Borrowers should check their credit scores and know what they are working with before applying. If the credit score needs work, start paying off old debts and getting rid of erroneous or outdated entries. It takes some work but is well worth the time. 
  • Get a letter from the HR department to prove tenure of employment. Borrowers will also need proof of income. They should gather check stubs and tax records. It also helps to have bank records available in case the lender asks for them. 
  • Always compare loan offers to determine the best interest rate. Never accept the first offer without researching. 

Get Started Today

There is no better time than the present to pursue a low-interest personal loan. Lenders should begin planning in advance, so they will be ready to meet the lender’s demands.