How Personal Loan Interest is Calculated and What are the Factors that it Depends on?

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personal loan interest

Emergencies can crop up anytime, banks and NBFCs in India offer personal loans that can be utilized to recover from financial hassles. Not just this, one can avail this type of loan to visit his dream holiday destination, for home renovation purposes or even for buying a new smartphone or laptop.

No matter what the case is, personal loans have emerged as a great way to help individuals take care of their financial problems in an easy way by offering quick access to funds. 

However, when getting a personal loan, many borrowers miss out on paying attention to the ‘interest rate’ factor that can have a huge impact on one’s financial future.

In simple terms, the interest rate is nothing but the amount charged by the lender on the principal amount taken; it is noted on an annual percentage rate. This rate is highly influenced by several factors that a borrower should ideally know about when applying for a personal loan in India.

If you are looking to avail a personal loan in India, then read below the factors that have an impact on the interest rates.

What is a personal loan?

As the name suggests, a personal loan is a type of unsecured loan that you can apply for any purpose ranging from buying a gadget, funding a holiday, financing your child’s education, spending on a wedding or any other purpose. These loans are generally provided for a tenure of 12 months-60 months at an interest rate ranging from 9%- 30%. 

The interest rate for a personal loan can vary from bank to bank depending on the eligibility criteria set by it and on how well the borrower meets with the set criteria. Due to this, you may get the same loan amount at varying interest rates from different financial institutions.

Crucial factors that have an impact on personal loan interest rates

Credit score: Your credit score is a three-digit numeric score generated by credit bureaus in India that help lenders determine your credit behaviour. The score ranges between 300-900 with 300 being the lowest and 900 the highest.

A high credit score acts as a validation of good credit behaviour, whereas a low credit score is considered a sign of bad credit behaviour. The score is generated based on the past timely payments made towards your loans and credit cards.

Defaulting on any payment or late payment of even a single EMI can lead to a low credit score, thus marking your credit profile to be a high-on risk one. This is one of the most important factors considered by the lenders as a score below 600-750 leads to rejection of the application. The score has a huge impact on the interest rate as generally loans are offered at a high-interest rate to individuals with a low credit score.

Therefore, any decline in the credit score can highly influence the personal loan interest rate offered to you.

Monthly income: For lenders, disbursing the loan to high-income individuals is always a safe bet. Individuals with high income are considered steady enough to repay the loan on time.

Therefore, the higher the income, the higher the chances of you getting a big loan amount at a low-interest rate. For instance, an individual with a salary of 50,000 can get a personal loan at an interest rate of 15%-20%, whereas, one with a salary of Rs. 1 lakh per month can get the same loan amount at an interest rate of 12%-16%. Banks usually consider the net in hand salary and not the CTC when approving the loan amount of salaried individuals.

Company name: Working with a reputed employer can help you fetch a good deal not just in terms of the loan amount but also in case of interest rate offered by the lender.

Employees working for reputed companies are considered to be stable with the capability of repaying the EMIs on time in comparison to the ones working for small companies. The loan interest rates also depend on the designation that you hold in the company. In addition to this, employees nearing retirement would be charged high-interest rates.

Existing relationship: Banks appreciate loyalty and if you hold a salary bank account with them or have a saving account in which you maintain the minimum balance, then you can enjoy special privileges and benefits offered.

Having a good payment record of timely EMI payments can fetch you a good deal from your bank instead. In addition to this, if you are an employee working for a reputed bank, then you can get a personal loan at a low-interest rate as a part of their employee benefits programme.

Now that you have understood the factors that have an impact on the interest rate, let’s understand how personal loan EMI is calculated. 

How personal loan EMI is calculated?

To put it simply, personal EMI i.e. equated monthly installment is calculated based on the below formula.

EMI Amount = [P x R x (1+R)^N]/[(1+R)^N-1]

In the above formula, P stands for principal amount i.e. the original loan amount sanctioned to you by the bank based on which the interest is calculated.

R stands for rate of interest 

N stands for the tenure of the loan

You can either calculate the EMI using the above formula or simply use a personal loan calculator online that will give you an idea of how much EMI you will have to pay and also the total interest you will be paying to the bank over the tenure of your loan.

Now that you know about how the above factors have a direct impact on personal loan interest rates, it’s important that you ensure you do not miss out on making timely EMI payments of your credit cards and loans and have a stable source of income to get the money at low-interest rate.

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