Banks and non-banking financial companies (NBFCs) usually use risk-based pricing methods for setting the interest rates for their personal loan applicants. As the unsecured nature of personal loans increases the credit risk for the lenders, they use multiple factors as part of their risk-based rate setting approach to determine the interest rates for their personal loan applicants. Let us understand these factors in detail below:
Credit Scores
As the credit score of an individual acts as a numerical indicator of his/her creditworthiness, personal loan lenders factor in credit scores for determining the credit risk associated with their loan applicants. Lenders usually prefer loan applicants having credit scores of 750 and above as they consider such applicants to be financially disciplined and thus, lending to such applicants involves a lower credit risk. This also leads many lenders to offer personal loans at lower interest rates to applicants having high credit scores. Applicants having lower credit scores usually have lower chances of personal loan approval or they are charged higher interest rates on their loans due to the involvement of higher credit risk.
Individuals can improve or maintain their credit scores by following healthy credit practices like settling their credit card bills or repaying the EMI on their existing loan(s) within their due dates, avoiding multiple loan/credit card applications within short durations, etc. Personal loan applicants should also fetch their credit reports at regular intervals to check for any clerical errors or incorrect information present in their credit reports. As errors or inaccurate information in the credit report can adversely impact the credit score and future loan eligibility of an individual, these should be reported both to the concerned credit bureau and the lender for rectification. Rectified credit reports would improve their credit scores and thereby, increase their chances of availing personal loans at lower interest rates.
Employment profile
Many lenders consider the employment profile of their personal loan applicants while deciding their interest rates. Such lenders usually prefer offering lower personal loan interest rates to salaried employees over self-employed applicants due to the higher income certainty of the former. Among salaried loan applicants, those working with the government or with public sector entities are more likely to avail personal loans at lower interest rates due to their higher job security. They are followed by individuals employed with reputed private sector companies as their capacity to withstand economic headwinds is usually higher than other private sector organisations. Similarly, among non-salaried personal loan applicants, professionals like doctors or chartered accountants have higher chances of availing personal loans at lower interest rates compared to self-employed non-professionals.
Income
Lenders usually consider the monthly income of their loan applicants while setting the interest rates on their personal loans. They consider personal loan applicants with higher incomes as having higher repayment capacity. This, in turn, reduces the credit risk for the lenders as personal loan applicants with higher repayment capacity are less likely to default on their loans. Therefore, many lenders pass on this benefit to applicants with higher repayment capacity by offering them personal loans at lower interest rates.
Note that lenders usually prefer offering personal loans to those having their monthly loan repayment obligations (including the EMI of the proposed personal loan) within 50%-55% of their net monthly income. Lenders may reject the loan applications of those exceeding this limit or sanction them personal loans at higher interest rates. Thus, applicants should use online Personal Loan EMI Calculators to know whether their total monthly obligations, after including the EMI of the proposed personal loan, is within the aforementioned limit. Loan applicants having the desired EMI/NMI ratio may be able to negotiate with their lenders for lower interest rates on their personal loans. Applicants exceeding the above mentioned limit can opt for longer loan tenures on their proposed personal loans to increase their chances of loan approval and thereby, avail personal loans at lower interest rates.
Existing consumer relationship with banks/NBFC
Many lenders offer preferential personal loans interest rates to their existing customers. Therefore, those planning to avail personal loans should first get in touch with their respective banks/NBFCs with whom they maintain deposit accounts or have availed loans or credit cards. The interest rates offered by such lenders can be used as a benchmark and can be compared with personal loan interest rates offered by other banks/NBFCs.
Many lenders also offer pre-approved personal loans to their existing customers based on their credit profile, income, employer’s profile, etc. Being pre-approved, such personal loans usually come with instant loan disbursal within minutes or at most within the same day of making the loan application.
Conclusion
The interest rates offered to personal loan applicants can vary across lenders based on their credit evaluation process and their risk appetite. Hence, personal loan applicants should gain a better understanding of the role played by the above mentioned factors in influencing their personal loan interest rates. Doing so would also enable loan applicants to take corrective measures, if required, to improve their chances of availing personal loans at lower interest rates.
