When you apply for a personal loan, one of the biggest factors affecting your EMI is the interest rate. But how do banks and NBFCs decide what rate to offer you?
Unlike home or car loans, personal loans are unsecured, meaning they don’t require collateral — so lenders depend heavily on your financial profile to determine the risk.
Here’s a clear and simple guide to understanding how lenders calculate personal loan interest rates.
1. Your Credit Score Has the Biggest Impact
Your credit score (CIBIL/Experian) signals how trustworthy you are as a borrower.
Higher credit score = lower interest
750+ → Best rates
650–749 → Moderate rates
Below 650 → High rates or loan rejection
A strong credit score reduces lender risk, so they reward you with better pricing.
2. Your Income Level & Stability
Higher and stable income = lower risk for lenders.
They check:
Monthly salary
Type of employer
Work experience
Stability (frequent job changes increase risk)
Government employees, PSU employees, and top MNC workers often get preferential rates.
3. Loan Amount & Tenure Influence the Rate
Loan Amount
Small loans (e.g., ₹50,000 – ₹1 lakh) may have slightly higher rates
Higher loan amounts can get better rates if creditworthiness is strong
Tenure
Shorter tenure → lower total interest, but EMI is higher
Longer tenure → slightly higher interest rate due to increased risk
4. Debt-to-Income Ratio (DTI)
DTI = Total EMIs / Monthly Income
Lower DTI = lower interest rate
Higher DTI = higher rate or rejection
Lenders prefer DTI below 40%.
5. Employer Category Matters
Many lenders classify employers into categories:
Category A: Govt, PSUs, Top MNCs → Lowest interest
Category B: Mid-sized companies → Standard interest
Category C: Small/private firms → Higher interest
This is because stability of income reduces risk.
6. Existing Relationship With the Bank
Banks often give special rates to:
Salary account holders
Long-term customers
Existing loan customers with good repayment history
Pre-approved borrowers
This lowers processing time and cost for the bank, so they offer better pricing.
7. The Formula Lenders Use (Conceptual)
Personal loans usually use reducing balance interest, not flat rate.
EMI Formula
EMI = [P × R × (1+R)^N] / [(1+R)^N − 1]
Where:
P = Loan amount
R = Monthly interest rate
N = Tenure in months
Interest is charged only on the outstanding amount each month.
8. Other Factors That Influence the Rate
Age of the borrower
City of residence
Market interest rate conditions
Reserve Bank of India (RBI) policy stance
Festive or promotional offers
9. Compare Fixed vs. Floating Personal Loan Rates
Though most personal loans have fixed interest rates, some lenders offer floating or hybrid schemes.
Fixed rate: EMI stays the same throughout
Floating rate: EMI may change depending on economic conditions
Fixed rates are more common due to predictability.
10. How to Get the Lowest Interest Rate
✔ Maintain a credit score above 750
✔ Keep credit card utilisation low
✔ Reduce existing EMIs before applying
✔ Choose a shorter tenure
✔ Apply with your salary bank
✔ Avoid frequent loan applications
✔ Compare offers from multiple lenders
Small improvements in your financial profile can significantly reduce the final interest rate.
FAQs
1. What is the average personal loan interest rate in India?
Typically between 10% and 24% per year, depending on your profile and lender.
2. Does a higher salary get you a lower interest rate?
Yes, higher and stable income reduces risk.
3. Why do people with weak credit scores get higher rates?
They are considered higher-risk borrowers.
4. Do banks offer different interest rates to different customers?
Yes — interest rates are not uniform and depend heavily on each borrower’s risk profile.
5. Is personal loan interest calculated on flat or reducing balance?
Most lenders use reducing balance, which is fairer and more transparent.
Published on : 19th November
Published by : SMITA
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