Naira Citlali
Written by Naira Citlali
Last updated: May.19,2022

Personal loan interest rate, also known as the annual percentage rate APR, is the rate at which you pay interest on a loan on an annual basis. Your personal loan interest rate can vary from lender to lender and depends on your creditworthiness, tenure of the loan and several other factors.

The personal loan interest rates across the country range from 4% to 36%, depending on your situation and the lender you choose. Generally, the interest rate, your lender will offer you depends on your creditworthiness.

The national average personal loan rate by the end of April 2022, was recorded at 10.50%. However, this rate fluctuated from 10.28% to10.50% during the past two months. If you are planning to get a personal loan, this is the perfect time for you to lock in a low interest rate. 

Why Is Interest Rate Important in Personal Loans?

The interest rate is important because it affects the total amount you’ll pay to your lender. A minimal rise in your personal loan interest rate can result in higher payments and you could end up paying much more down the road.

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It is also important to understand the method used to calculate interest on your personal loan amount. There are three methods: Simple, Compounded and Add-On. The most common method is the Simple Interest Method where the interest is charged on the total loan amount and the interest is not compounded. For instance, if your annual interest rate is 10% and you borrow $10,000, you’ll pay interest of 10% on only $10,000.

Compound interest and add-on interest loans are more expensive than standard simple interest loans as the interest is compounded on a periodic basis.

Most lenders charge simple interest annually, hence the name Annual Percentage Rate APR is used alternatively.

Factors that Affect Your Personal Loan Interest Rate

Here are the most common factors that can affect your personal loan interest rate.

Ⅰ. The Creditworthiness of the Borrower:

Borrowers with high creditworthiness (or a good credit score) can secure loans at lower interest rates as the lenders expect them to pay the entire loan amount timely. And borrowers with lower credit scores are offered higher interest rates as they have a higher risk of default.

The credit report is a detailed document that shows a person’s past and current loans, history of missed or late payments, the total debt amount owed, credit usage and how long ago the person acquired their first debt.

Although the credit score tells a lender a lot about a person’s ability to manage debt, lenders also consider analyzing the credit risk of a borrower. Credit risk refers to the possibility of default on loan repayment.

The credit risk of the borrower is analyzed based on 5 factors also known as the 5 C’s of creditworthiness:

  1. 1. Capacity

A borrower’s capacity depends on their job security, employment history, level of income, expenses and spending habits. For instance, lenders are hesitant to give loans to borrowers who have small businesses with lower cash flows or individuals who have less financial freedom. 

Therefore, lenders evaluate the borrower’s capacity to decide the right interest rate.

Lightstream is a leading lending company that offers low-interest rates on personal loans and without any fees to borrowers with excellent credit scores.  

  1. 2. Capital

The capital factor is about assessing the net worth of a borrower. Lenders tend to offer better interest rates to borrowers with a higher net worth or a low debt-to-income ratio. Higher capital means higher financial stability because the borrower can pay off the debt by dipping into their savings or investments in the worst situation.

For instance, high-income individuals who live paycheck to paycheck and don’t own many assets are offered the worst rates.

  1. 3. Conditions

The effect of external conditions (such as economy, market or industry, political situation, etc.) on the borrower’s income can sometimes distress their ability to repay the loan. For instance, a borrower’s import business can get hit hard by an import ban which can lead to winding up.

  1. 4. Collateral

A collateral is a borrower’s pledge of an asset to secure a loan’s repayment. Land, bonds, jewelry or any other physical assets can be pledged to secure a loan, hence called secured loans. Selling the collateral is lender’s last resort to recover the debt.

  1. 5. Character

Character is the moral integrity and reputation of the borrower in paying down debt. Delayed or missed loan repayment in the past is a negative indicator that the borrower might be irresponsible in future.

Ⅱ. Tenure of the loan

The interest rate is usually higher for short-term loans. This is because when the loan is held for a shorter period of time, you’ll pay less total interest than you’d pay on a long-term loan. This is why most lenders prefer to offer lower interest rates on long-term loans. Some lenders also charge a pre-payment penalty for repaying the loan sooner. Therefore, you should compare several long-term and short-term options.

Credible is a free online marketplace for comparing lenders to find and compare the best personal loans. By comparing multiple offers from lenders, you can choose the right one that suits your needs and offers the best interest rate.

Ⅲ. The Lender’s Cost of Borrowing

Banks and other lending companies also borrow money from each other or investors at the federal funds rate. This cost of borrowing is included in the interest rate you are offered. If a bank or lender borrows the funds at a higher interest rate, it can also increase your interest rate.

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But different lenders can offer you different interest rates because all lenders do not have the same appetite for risk, and their overhead costs or other expenses can also differ drastically.

Ⅳ. Co-Borrowers

If you have added a co-borrower to the loan, their credit score can also affect the overall credit risk. Adding a co-borrower is only recommended in situations where the co-borrower has an excellent credit score so that it helps you secure a better interest rate. 

Ⅴ. Frequency of Payments

Most personal loans are simple interest loans with annual payment plans because of tough competition to gain more customers in the lending arena. However, if you have a bad credit score, your interest rate on annual payment plans will be higher. 

Adjusting the frequency of payments to semi-annual, quarterly or monthly might help you decrease your interest rate. 

Bottom Line

If you want to get a personal loan in a year or two, improve your credit score and reduce credit risk. The higher your creditworthiness, the better the personal loan interest rates you’ll get offered.

Getting a personal loan with a high-interest rate is easy but it can be a difficult path to tread. To get the best deal, compare lenders and choose the best option. If you find a lender that offers a low personal loan interest rate, look for a better one!


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