Lenders usually use risk-based pricing methods for fixing the interest rates of their personal loan applicants. Due to the unsecured nature of personal loans, the associated credit risk for lenders increases. To mitigate such risks, they use multiple factors as part of their risk-based pricing approach to fix interest rates for their personal loan applicants. Let us discuss each of these factors in detail as below:
An applicant’s credit score is a strong determinant of their creditworthiness; therefore, lenders look into it to determine credit risk in lending money to their loan applicants. Banks and NBFCs usually prefer approving personal loan applications of individuals having credit scores of 750 and above. This is because such applicants are considered to be financially disciplined and thus, lending money to such applicants involves a lower risk for lenders. Lower lending risk further leads to many lenders offering such applicants personal loans at lower interest rates. This further implies that applicants having lower credit scores have lower chances of availing personal loans and if they get it, it is usually at higher interest rates as they exhibit higher credit risk for lenders.
Individuals with lower credit scores can improve it by following healthy credit practices like timely repaying their loan EMIs or credit card bills, avoiding multiple loan/credit card applications within a short period, etc. They should also check their credit reports regularly to identify any errors or misinformation present in their reports. Some errors or inaccurate information can adversely affect credit scores; and thereby, the individual’s eligibility to avail credit in future. Therefore, individuals should keep a close eye on them and report to the concerned credit bureau and the lender for rectification.
Many banks and NBFCs factor in their applicants’ employment profile when setting their personal loan interest rates. Among salaried and self-employed applicants, they prefer offering personal loans to the former due to their higher income certainty. Among salaried applicants, government employees or those working with public sector entities are more likely to get personal loans at lower interest rates because of higher job security. Next in the list of preferred loan applicants are individuals working for reputed private sector companies as these companies are better at holding out against economic headwinds than other private sector organisations. Likewise, among non-salaried applicants, self-employed professionals like chartered accountants, doctors or architects have higher probability of availing personal loans at lower interest rates as compared to other self-employed non-professionals.
Lenders may also take into account their applicants’ net monthly income when setting personal loan interest rates for them. They equate applicants having higher incomes with having higher repayment capacity, which further translates into lower credit risk for lenders. Resultantly, many banks and NBFCs offer personal loans at lower interest rates to applicants having higher loan repayment capacity.
Keep in mind that lenders typically prefer giving out personal loans to borrowers whose monthly debt obligations (including the EMI of the proposed personal loan) fall within 50%-55% of their net monthly income. For example, SBI Personal Loan is offered to applicants whose loan repayment obligations (including EMI of the proposed loan) fall below 50%of their net monthly income. Applicants exceeding the aforementioned limit risk having their loan applications rejected. Even if they get the loan, it is most likely to be at a higher interest rate. To increase their chances of loan approval, applicants exceeding this limit can extend their loan tenure and thereby, lower their EMIs.
Consumer relationship with their lenders
Many lenders offer interest rate concessions on personal loans to their existing customers. Therefore, when looking for a personal loan, applicants should first enquire with the banks/ NBFCs with whom they have deposit/ credit card/ loan account(s). Prospective borrowers can use interest rates quoted by such lenders as a benchmark to compare personal loan offers by other banks and NBFCs and arrive at the best offer.
Many lenders also offer pre-approved personal loans to their existing customers on the basis of their credit score, income, employer’s profile, etc. As such loans are pre-approved, they usually come with instant loan approvals, paperless process and quick loan disbursals, which may take a few minutes or at the most a day from the time of applying for the loan.
Personal loan interest rates offered to applicants may vary across lenders due to their varying credit evaluation processes and risk appetite. Therefore, it is important for prospective applicants to understand how each factor influences their lender’s decision while setting their personal loan interest rates. Doing so would also help applicants in taking corrective steps, if required, to increase their chances of availing personal loans at lower interest rates.