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How Do Credit Ratings Affect Interest Rates For Personal Loans?

Last updated 03/26/2024 by

Whether you want a new deck, a kitchen remodel, or debt consolidation, a personal loan can help you make it happen. Typically when lenders advertise loans, they offer a range of available interest rates. But why is there a range, and how do lenders determine your interest rate?
Your credit score is a major factor when determining your interest rates, but it’s by no means the only one. Here are five main factors that determine the interest rate for a personal loan.

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Credit scores and APRs

All things being equal, the higher your credit score, the lower your interest rate. This table summarizes the rates you can expect based on your FICO credit score.

Unsecured vs. secured

There are two types of personal loans: secured and unsecured. Secured loans ask you to supply physical possessions as collateral. If you fail to make a payment, these possessions are repossessed.
Personal loans are typically unsecured, which means they don’t ask for any physical collateral. Because they lack this extra level of accountability, unsecured personal loans typically carry higher interest rates.

Income level

When you apply for a loan, you’re required to give proof of your ability to repay it. If your financial situation shows that making payments may be difficult, your interest rate may be higher. If your income drastically mismatches the sum you’re asking for, your loan application may be denied altogether.

Payment history

Your credit score and payment history tells the lender how likely you are to pay the loan back successfully. If you have a solid history of making payments on time, lenders will offer you a lower interest rate! But if you’re often late on your payments, your rates will be higher.

Credit utilization

Credit utilization is the measure of how much you use your credit on a day to day basis. If you have a credit card with a limit of $5000, and the current balance is $4900, your credit utilization will be high. Applicants with higher credit utilization will see higher interest rates on personal loans or may be denied the loan altogether.

Credit history

Your credit history shows your ability to handle credit accounts. Recently paid off loans, healthy mortgages, and credit card accounts in good standing will all indicate that you’re competent with your accounts. On the other hand, if you don’t have a mortgage or have never had a credit card, it’s harder for lenders to determine how you’ll handle loan payments. Naturally, your rates will be higher.
The common theme in all of these factors is risk. These factors are measuring sticks that borrowers use to estimate the likelihood that you’ll pay them back in full. The higher the risk, the higher the interest rate. The reasoning behind this is really the law of averages. If 10 high-risk borrowers are given loans, two of them might default on their payments. The high interest rates on the remaining eight ensure that the lender makes a profit despite these losses.
Personal loans can give you the freedom and flexibility to improve your life or achieve a given financial goal. The good news is, even if you’re a “higher risk” borrower, you may still be able to qualify for a loan at a higher interest rate. Just be sure to pay it back quickly to avoid growing your debt — or consider improving your credit scores before applying for any major loans.

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