Calculating actual personal loan interest rate can sometimes get tricky. It often gets confusing as interest rate and APR are two often interchangeably used terms. They refer to similar concepts but have slight differences when calculating the total interest charged on a loan. When deliberating the cost of a loan, it is essential to know the difference between the interest rate that is advertised and the APR, which includes all the additional costs and fees.
Interest Rate and APR
Interest rate: An interest rate is the percentage of the principal charged by the lender. In this, the principal is the amount of money you loan.
APR: The annual percentage rate or APR is always bigger than the interest rate as it is the total cost of the loan. APR includes not only the interest expenditure on loan but also all the fees and costs involved in procuring the loan. The expenses include one-time loan processing fees, broker fees, closing costs, etc.
Annual Percentage Rate signifies the total interest levied by a lender on loan. Thus, when choosing the lender, it is critical to pay attention to the APR, which is the actual cost of financing.
Let us now understand the ways in which personal loan interest rates are calculated.
Types of interest rates
A personal loan interest rate is calculated in one of the following two ways:
- Using flat interest rate
- Using reducing interest rate
Learn all you need to know about both types of personal loan interest rates here.
Flat interest rate
The flat interest rate method of interest calculation is traditionally applied to personal loans. It is also known by the name fixed interest rate and is pretty easy to understand.
Personal loan interest rate is calculated on the entire loan amount you have availed of—your principal loan amount. The principal is considered for calculating interest every month.
So, firstly, the total interest on your loan is calculated and added to your principal loan amount. The resultant amount is divided equally across your repayment tenure. So, with a flat personal loan interest rate, your monthly EMI remains the same for the entire loan repayment duration.
Reducing interest rate
Under the reducing interest rate method of calculating interest, the personal loan interest rate reduces every month. The interest is calculated upon the outstanding loan amount, which reduces every month.
When you pay your monthly installment, a part of it is paid as interest, and the rest is used towards paying off the principal amount. In this way, the principal amount reduces every month. As a result, the interest amount decreases as well. The interest amount gets lesser and lesser with every EMI when reducing interest rate is applied.
Factors influencing interest rates
Many factors influence interest rates. Some of them are mentioned here:
Competition in Private Banks
Private banks compete for specialized products. Where one bank can avail you of a good interest rates on a personal loan, another can help you with a better interest rate on car loans.
Only public banks provide lower interest rates on educational loans. The defaults on educational loans are high, which increases the burden of Non-Performing Assets (NPAs) for a private bank.
- Types of Loans
Interest rates are governed by the central bank based on the political and market situations in the country.
Interest rates are different for different types of loans in India. The interest rates for personal and educational loans are higher as they are unsecured loans without any assets as collateral. In contrast, the interest rates on car loans and home loans are lesser than secured investments for the bank with asset security to fall back on.
The interest rate fluctuates based on the type of loan you wish to secure. Where personal loan interest rates range from about 10% to 35%, the range for car loan interest rates is from 9.25% to 10%.
Calculating Interest Rate on Personal Loans
On personal loans, you usually get the maximum scope for negotiating on the rate. There is hardly any scope of negotiation in the car loan interest rate. However, a personal loan interest rate is calculated by the bank by analysing essential parameters like:
- Principal Amount
- Loan Tenure
- Repayment Schedule
- Employment Type
- Current Financial Position
- Credit Score
- Existing Liabilities
- Current Income
- Current Age
- Work Experience (total as well as in the current organization)
You can check if you are eligible for a personal loan using a personal loan eligibility calculator.
You can negotiate with the bank for a better personal loan interest rate by considering the following factors:
- Clearing your current dues
- Maintaining a steady professional life
- Including a well-earning co-applicant
- Improving your credit score
In order to calculate the interest you have to pay on a personal loan, you simply need to apply this formula: Interest = Loan Principal*Interest Rate (on a monthly basis)
Quick Loans of up to INR 5 Lakhs
To calculate the total interest over the life of the loan, you can use a personal loan interest calculator. To determine your monthly payments, you can use the EMI calculator for personal loans available on the PaySense website and app.
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