What Rising Personal Loan Rates Mean For Borrowers

Whether for medical expenses or purchasing a fancy item, covering a destination wedding or debt consolidation, a personal loan comes as a blessing. It can be a good solution when one does not want to dig into one’s own pocket or go through the hassle of borrowing from friends.

People opt for this type of loan primarily because it is collateral-free and because of the wide-range of purposes that can be fulfilled through a personal loan.

In fact, personal loans offer several advantages over other types of loans. But they may not be the right solution in all situations, especially taking into account the higher interest rates on these loans.

Lenders decide the interest rate on a personal loan depending on the applicant’s credit score, the availed loan amount and its repayment tenure.

The loans are either offered on a floating rate basis or carry a fixed interest rate. As the terms suggest, a floating rate changes as per market conditions while the fixed remains unchanged throughout the loan tenure.

Interest Rates

Commercial banks in India borrow money from the Reserve Bank of India (RBI). The RBI charges commercial banks an interest fee which is known as the repo rate. Since an increase in the repo rate by a few points increases the cost of borrowing for the banks, they share the cost with the customers in the form of higher interest rates on loans and deposits. On the contrary, a cut in the repo rate lowers the cost of borrowing for commercial banks. This also means a decline in charges for individuals.

In India, personal loans are offered at interest rates ranging from 10-25% per annum, with customers lacking a strong credit score or having higher debt obligations paying a higher rate.

Some of the other causes that could possibly lead to an increased interest rate are:

• Poor Credit Score:

A credit score of 750 or above is considered ideal by lenders for sanctioning a loan request. A score less than 700 may also qualify for a personal loan, but at a higher interest rate.

• Less Income:

Individuals belonging to the lower income group may find it difficult to bargain for a personal loan at a lower interest rate. Since lenders fear the possibilities of a payment default, lower income translates into a higher interest rate.

• Nature Of Employment:

The interest rates offered to self-employed applicants vary from salaried individuals. A lower rate of interest also depends on the employer details. So, the personal loan interest rate quoted by the lender will be high for individuals associated with lesser-known companies.

• Age:

Individuals close to their retirement age may be charged a higher interest rate.

Impact Of Higher Interest Rate On Borrowers

Since mid-2022, the RBI has been increasing its repo rate to control inflation. This has prompted banks and non-banking finance companies to pass on the rate hikes to borrowers. In effect, this means the rate of interest on every type of loan, including gold loans, home homes, business loans and personal loans, has gone up.

Higher interest results in higher equated monthly installments (EMI), which can result in reduced savings. In turn, this may force borrowers to change their spending habits and reduce expenses on discretionary items such as expensive gadgets or postpone non-urgent expenditure such as house re-modelling.

If the borrower keeps the EMI unchanged, lenders will extend the loan tenure. Many borrowers prefer to extend the term of the loan at such times. But it must be noted that higher the tenure of a loan, the more is the overall interest payout. So, it might be better to avoid extending the tenure if possible and instead opt for the higher EMI in case of a rate hike.

Conclusion

The higher the interest rate, the more expensive is the loan. There are a few things that can possibly help borrowers save money on a personal loan. For instance, borrowers should work towards improving their credit score. Some lenders may sanction a loan request on a bad credit, but that may be subjected to higher interest rates.

The next is keeping the credit utilization rate low, typically below 30%. Another important aspect to consider while shopping around for a personal loan is to compare several lenders to pick the interest rate and payment terms that fits the best.

Since it is always wise to opt for loans from a reliable credit institution, you can choose IIFL Finance to meet your needs. IIFL Finance is a leading investment and financial service provider in India, offering various types of loans. The company offers personal loans ranging from Rs 5,000 to Rs 5 lakh at competitive rates of interest and flexible repayment terms with tenure of as long as 42 months.