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Personal loans can come in handy in all kinds of situations. You can use one to consolidate debt, buy a vehicle, or do home repairs. In most cases, these loans are unsecured, which means that you will not have provided any property, such as your home, as collateral.
If you are looking for a personal loan, you will find them offered by a variety of institutions, from online lenders to your local credit union. Just as there are various lenders, terms and interest rates can vary as well.
To make sure you get the best personal loan rate, keep reading for more information on how APRs are calculated and what you can do to reduce the amount of interest you pay.
How Do Banks Decide Personal Loan Rates?
The price – that is, the interest rate – of a personal loan can be based on four factors, according to the Federal Reserve Bank of Minnesota:
- The cost to the bank of obtaining loaned funds.
- Operating expenses for servicing the loan, such as processing payments and issuing statements.
- A risk premium based on the likelihood that someone will default on the loan.
- The profit margin, which is how the bank makes money on the loan.
Of course, banks should also take into consideration the rates offered by other lenders to ensure that their products are competitive. To attract customers, financial institutions are sometimes willing to reduce their profit margins in order to offer the best possible personal loan rates.
What can impact the rate you receive?
Lenders generally do not have an interest rate that they offer to all customers. Instead, they customize the rates based on the following factors:
The best personal loan rates are reserved for those with excellent credit scores. If you have a lower credit score, a lender may think you are at greater risk of default and increase the rate accordingly.
Many institutions offer lower rates for shorter repayment terms.
Amount of the loan
There is more risk in lending more money, so the amount you borrow can affect the rate you receive.
As another way to assess risk, lenders will consider how much debt you already owe and how much income you earn. If your debt to income ratio is high, a bank may charge higher interest because it is considered a riskier loan.
Since your debt and credit rating can have a significant impact on your interest rate, it’s always a good idea to pay off existing balances before applying for a new loan, if possible.
How do you know if you are getting a good rate?
The best way to determine if you are getting a good rate is to compare it to what is available in the market.
The average 24-month personal loan rate was 9.39% in August 2021, according to the Federal Reserve. So, generally speaking, any amount less than this amount can be considered a good rate.
However, what constitutes a good rate for you could be very different. If you have a low credit score, are asking for a longer term, or have significant existing debt, you could be paying a much higher rate. On the other hand, if you have a great credit rating and aren’t in debt, you could get a rate several percentage points lower than average.
According to the latest figures from MoneyRate, personal loan rates range from 4.99% to 35.99% with major online lenders. Often, online institutions can offer lower rates than traditional banks because they don’t have the branch maintenance fees.
Tips for Comparing Personal Loan Rates
If you’re thinking about getting a personal loan, here are some ways you can compare rates and select the best loan.
Get started with a personal loan calculator
Before you start comparing rates, you need to know how much you plan to borrow and how long it will take to pay it off. If you’re not sure what you can afford, use a personal loan calculator. These allow you to experiment with different balances, interest rates and repayment periods to find the ideal terms for your situation.
Compare apples to apples
Once you know what you can afford, it’s time to search for a lender who will meet your needs. When looking for the best personal loan rates online, be sure to compare the same loan terms. The rates for a 36-month loan, for example, can differ significantly from a 60-month loan.
Watch online and offline
Online lenders are convenient and often have lower interest rates. However, don’t discount your local credit union or a traditional bank. They may offer competitive rates, but you will never know that unless you check it out.
After you identify potential lenders, see if they will pre-qualify you for a loan. Prequalification not only ensures that you will be eligible for a loan, but also provides a good estimate of your potential interest rate. This process uses a soft survey to check your credit and will not affect your score in the same way as a hard survey, which is used during the application process itself.
Personal loans can be flexible and can be cheaper than high interest credit cards. By using these tips, you can find the right loan at the right price for your financial needs.