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Unlike home or car loans, the personal loans are unsecured form of loans. So there is no collateral for lenders. So with no recourse to any security in case the failure to repay the loan, the lenders give compensate themselves for higher default risk that they are taking by charging higher interest rate.
So how do lenders decide what rate to charge from different personal loan customers? There are several factors that are used to assess the risk – current income, income stability, profession, age, existing loan EMIs, credit history, etc.
A good credit history means that you do not have too many loans. Also, you have regularly paid your loan EMIs in past. The idea of credit score is to help lenders gauge your riskiness. It is an indicator of your credit-worthiness and is calculated based on your financial history. So higher the risk assessed (lower credit score), higher will be your loan interest rate.
To see how higher interest rates effect your loan EMIs, try using the personal loan EMI calculators online. You will get a good idea of the actual link between your risk (which results in change in interest rates) and your EMIs.
But it is not that only your credit score can affect your personal loan rates. How you handle you personal loan will also affect your credit score. If you are irregular with your new loan EMIs and fail to pay them on time, it will reflect in your credit score. Slowly your credit score will start deteriorating. Remember that even a single missed payment can negatively affect your credit score. So, if you have taken a personal loan recently, ensure that monthly payments are done on time.
Thanks for reading this article. I'd love to hear your opinion. Please use the comments section below to share your thoughts. I frequently write new articles that also cover several other aspects of personal finance including credit cards, financial goals, health insurance, income tax, life insurance, mutual funds, retirement planning, and much more. You can Subscribe through Email and receive new articles directly in your Inbox or you can Subscribe through the RSS Feed and receive new articles in your feed reader.