12 MAY, 2022

When you need to raise quick funds to meet your personal financial obligations, you can take a personal loan. Due to its quick funding and flexible repayment options, personal loans have become a popular alternative to credit cards. These can help with purposes like debt consolidation, travel, wedding, medical emergency, etc. However, it’s essential to consider the cost of borrowing, which is dependent on the personal loan interest rate. Therefore, it’s important to know how the personal loan interest rates are calculated.


Factors affecting personal loan interest rate

Many factors come into play when a financial institution decides on the interest rates for personal loans. The interest rate on your loan is directly linked to the risk associated with lending money to you. Lenders consider your income to be directly proportional to your credibility and thus, your ability to repay the loan.

However, apart from income, there are other factors that can affect your repayment capacity and creditworthiness. Hence, lenders also take into account the following factors when calculating personal loan interest rates for borrowers:


  • Credit score

A good credit score indicates that you are a credible borrower who pays back Equated Monthly Instalments (EMIs) on time. A high credit score will make lenders more comfortable in lending you money. If your credit score is 750 or above, you are considered a low-risk customer and will get access to lower interest rates from financial institutions. If your credit score is below 730, lenders may still approve your loan application, but may charge a higher interest rate. This is because of the additional risk involved in lending money to people with low credit scores.


  • Loan amount

The amount of loan you can avail is primarily dependent on your income and credit score. Based on the quantum of the loan you choose to borrow, your interest rate would also be affected. The higher the loan you apply for, the higher the interest rate you might be charged as it would carry a higher credit risk.


  • Loan tenure

Lenders often give you a tenure range within which you can repay the loan. Choosing a shorter tenure would mean you may have higher EMIs, but the interest outgo would be lesser. Similarly, if the tenure is longer, the EMI would be lower, but the interest outgo would be more.


Formula for calculating personal loan EMIs

The EMI on a personal loan can be derived from a mathematical formula. This includes P (the principal amount borrowed), R (loan interest rate), and T (tenure of the loan in months). And hence the formula would be:

EMI = P × r × (1 + r)n/((1 + r)n - 1)

Alternatively, you can also use an EMI calculator to find the EMI value instantly. This calculator would also give you a clear picture of the total amount of interest payable over the loan tenure as well as the proportion of interest and principal in each EMI payment.


To sum it up

Personal loan interest rates can increase or decrease your total cost of borrowing. Now that you know what goes into calculating the personal loan interest rate, you assess your personal loan eligibility and get an idea about what kind of personal loan interest rate you could get.

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Disclaimer: This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. The Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from the Bank. The Bank, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein. Tax laws are subject to amendment from time to time. The above information is for general understanding and reference. This is not legal advice or tax advice, and users are advised to consult their tax advisors before making any decision or taking any action.