Loan interest

What factors affect personal loan interest rates?

Understand the process and factors that affect interest rates before applying for a personal loan. (iStock)

A personal loan is a flexible financing tool that you can use to buy a car, consolidate debt, make home repairs or pay for education. And if your credit score is good, you could be eligible for $100,000.

If you’re considering getting a personal loan, the first thing you should do is visit an online marketplace like Credible to compare loan options from multiple lenders at once, which will save you time. Rates can vary from 3.49% to 35.99%, and you might be wondering why there is such a gap. Lenders look at several criteria to determine the rate to offer you.

1. Credit score

Your credit score is a number assigned by reporting agencies such as Equifax, Experian, and TransUnion, and it helps a lender assess risk. Your score will be based on your outstanding balances, your repayment history, your credit mix and the length of your account. Credit scores range between 300 and 850, with a higher score being better.

Another thing that affects your credit score is how often lenders pull your credit history. To prequalify you, lenders will conduct a soft inquiry, which will not affect your credit score. When you apply for credit, however, a lender does a thorough investigation. Serious inquiries stay on your report for two years and make up about 10% of your credit score. The fewer difficult requests you have, the better. If you’re just checking rates, be sure to use a site like Credible which uses flexible inquiries to provide pre-qualified rates from multiple lenders without affecting your credit score.


2. Debt to income ratio

Another determining factor is the amount of debt you have relative to your gross income, which is your debt-to-income ratio. Debt includes loans, mortgages, leases, and credit cards, but not monthly expenses, such as utilities or groceries.

If your gross income is $5,000 per month and your debts total $2,100, your debt-to-income ratio is 42%. According to Consumer Financial Protection Bureau, mortgage lenders seek debt-to-income ratios of 43% or less. For personal loans, a lender’s standards may vary. The lower your ratio, the better your rates are likely to be.


3. Work history and income

Lenders will also want to know how you plan to repay the loan, and they usually look at your work history. Many lenders look at the last 24 months of employment history, while some can go back further. They are looking for a strong employment record. For example, someone who has held the same job for two years will seem less at risk than someone who has just arrived on the labor market.

Your income can also impact your rate. Some lenders set low or no minimum income requirements, but borrowers with higher incomes are usually offered lower interest rates. The repayment of your loan will have an impact on your monthly budget. Credible’s online calculator can help you figure out the monthly payment to make sure you can afford it.


4. Duration and amount of the loan

The length of the loan will also have an impact on your interest rate. Personal loans can range from one to seven years. Longer term loans generally have higher rates than a shorter term loan.

The amount of money you want to borrow can also impact the interest rate. Lenders assume a higher risk by granting a higher loan amount and therefore they may charge a higher rate of interest. You can easily find out how the loan amount can impact the rate by visiting Credible, where you can see rates for loan amounts ranging from $1,000 to $100,000.


5. Warranty

Most personal loans are unsecured. However, if you have bad credit or a short work history, you may be able to lower your rate by offering some form of collateral. If the purpose of the loan is to buy a car, for example, you can use the car to secure the loan. If you have other valuables, such as a CD, lenders can use this collateral to lower your interest rate. If a borrower does not pay, lenders will take collateral to cover their costs, thereby limiting their risk.

By knowing what a lender considers before approving a personal loan, you are taking steps to improve your situation before asking for the lowest interest rate.

You can also improve your chances of getting approved quickly. A personalized loan offer can help you achieve your financial goals and stay on track for the future, provided you use it responsibly.