When you apply for a personal loan you might have noticed that you are charged higher rates of interest as compared to other loans. Also, the rates of interest offered by different lenders vary widely depending on a lot of factors. If you opt for a loan through a loan app, then you might see a lower interest rate than the interest rates charged by the traditional banks. This is primarily because the operational costs of the personal loan apps are much lower than that of the traditional banks.
Read on to understand why the banks are charging higher interest rates on personal loans. Knowing the factors affecting the interest rate will help you get the best personal loan at the lowest possible interest rate.
Reasons Why Banks Charge High Rates of Interest
In addition to different lenders offering different rates of interest, you may notice that many times the same lender may provide you with a higher rate of interest for the same loan on different days. Below are the reasons why banks charge you a high rate of interest.
1. Borrower’s Profile
By taking into account all factors connected to the borrower’s profile, the needed loan amount, the borrower’s ability to repay the loan, previous borrowings, previous debts, and credit score; they develop a customized interest rate for personal loans. If you have a low credit score, banks are going to charge you a high rate of interest as they see the risk associated with your profile as high.
Also, if you have too many previous debts, or low income, the bank will see you as a high risk borrower. To balance this risk, they offer you the loan at a higher interest rate. When you apply for the loan through a loan app, they just check your repayment capability.
2. Lack of Collateral
In other types of loans like home loans, two-wheeler loans, or commercial loans the bank asks the borrower for collateral for securing the loan. As a result, a bank or other financial institution runs substantially lower risks. In contrast, personal loans have no collateral. Due to the lack of collateral in personal loans banks are exposed to substantial risk. This is one of the major reasons why lenders typically charge a higher interest rate for personal loans in order to offset this risk component. Making it a key element that influences the interest rate is risk rating.
3. High Risk of Defaults
Due to the lack of asset security, personal loans often have greater default rates than other types of loans. As a result, banks now have a higher share of non-performing assets (NPAs). Personal loans and student loans, both of these loans are unsecured loans granted solely on the basis of the credit history and repayment capabilities of the borrower. Hence higher interest rates are necessary for banks in order to make up for the same. In the case of a home loan or auto loan, the bank has the right to auction the property and recover the loan amount. However, personal loans do not have such options for recovery.
4. Lender of Last Resort
When a country bank is on the verge to collapse, the central banks help it by lending them funds in their time of need. Just like that when you are in need of urgent funds banks provide you funds with a personal loan so that you can fulfill your financial needs. These urgent needs may include paying off debts, taking care of medical or hospital bills, covering wedding costs, putting down payment on a car or house, etc. Banks and other financial entities profit from this circumstance by providing loans with higher interest rates. Additionally, personal loans are perhaps the only product on which banks impose additional fees. They do this in an effort to reduce the overall NPA percentage of the bank’s total assets and protect themselves from losses due to defaults.
Tips to Get a Low Rate of Interest on a Loan
Personal loan interest rates can be quite high sometimes but we have some tips for you that can help you gain a low-interest rate on your personal loan:
- Always maintain a good credit score.
- Never apply for too many loans at the same time.
- Clear off your previous debts before you apply for a personal loan.
- Don’t switch too many jobs and maintain a fixed monthly income.
- Keep a good relationship with your lender.
- Apply for a loan during festive seasons for offers and other benefits.
- Show as many sources of income as you can.
- Do not exceed your debt-to-income ratio.
There are many reasons why bank charges a high rate of interest on a personal loan. You should understand these reasons before you apply for a personal loan so that you don’t end up signing up for something that you are totally unaware of. A personal loan can truly save you from emergency situations. Though they are unsecured loans with high rates of interest they are the most easily available type of loans. We have some helpful advice for you. Before you apply for a personal loan you can check the interest rate and EMI of your loan on the personal loan app. Every lender provides a loan app to borrowers which have options and flexibility for you to change the loan amount and duration and decide upon the amount which suits you the best and doesn’t cause any burden on you.