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One size does not fit all when it comes to personal loan interest rates, which can vary wildly depending on the lender and your borrowing power.
As of February 2018, the average annual percentage rate on a two-year personal loan from a commercial bank was 10.22%, according to Federal Reserve data for the first quarter of 2018.
While that might not sound too bad, some personal loan companies offer loans with an annual percentage rate of up to 36%. Other lenders may go even higher than that if you have bad credit.
In fact, the differences between a personal loan with a low rate, one that’s merely average and one that’s sky-high often come down to your credit history and credit scores. Generally, the higher your credit scores, the more likely you are to qualify for a loan with lower interest rates. And the lower your credit scores, the more likely you are to face higher interest rates.
Before applying for a personal loan, read on to learn about personal loans and what could help you qualify for a loan with low interest rates.
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What is a personal loan?
A personal loan is a type of installment loan that you repay with interest in set monthly payments over the repayment period. You can generally use personal loan funds for just about anything, but lenders can have limitations. Common uses include debt consolidation, home improvements or repairs, credit card debt refinancing and emergency expenses.
There are two general types of personal loans: unsecured and secured.
An unsecured personal loan isn’t backed by any collateral, while a secured personal loan is backed by collateral, such as money in a savings account or a certificate of deposit. If you default on a secured loan, the lender may claim the asset to satisfy the debt.
You can find personal loans at many traditional banks, credit unions and some online lenders. There’s no single best source for personal loans, so it’s important to shop around to ensure you get the best terms for you.
How personal loan rates compare
Different loan products, like personal loans, credit cards and mortgages, may come with varying interest rate ranges.
Steve Allocca, president of Lending Club, points to two main factors that lenders may be looking at when deciding whether or not to lend you money: “your credit history and profile, and the type of credit or loan you’re looking for.”
Here are the current average interest rates for Q1 2018 for personal loans compared to auto loans and credit cards offered at commercial banks, according to the Federal Reserve.
Average interest rate
Personal loan (2-year loan)
New auto loan (4-year loan)
Credit card plan (on which interest was charged)
If you’re buying a car, you may get a better rate with an auto loan than with a personal loan. But that same logic may not apply to a personal loan vs. a credit card. That’s because a credit card is a form of revolving credit. And if your card has a grace period, you won’t have to pay any interest on purchases as long as you are paying off your balance in full and on time each month.
When comparing personal loan rates to products like auto title loans and payday loans, which can have APRs that can climb to around 300% or more, the gap is much greater.
How lenders set interest rates
Lenders offer borrowers a range of fixed rates and/or variable rates and often use a method called risk-based pricing to determine the interest rate and terms on your loan.
As the name suggests, the risk-based pricing method tries to determine how much risk you as the borrower pose to the lender based on your credit scores and other factors. Lenders may use this method along with other information to determine your APR.
“If your application and credit history suggest you’re a lower credit risk,” says Allocca, “your personal loan offer will probably have a lower APR. If your application and credit history suggest you’re a higher credit risk, your offer will likely have a higher APR.”
Here’s an example of how credit scores can affect interest rates. According to FICO as of July 13, 2018, mortgage shoppers with FICO® credit scores in the 620–639 range (on a scale of 300 to 850) might qualify for a 30-year fixed $200,000 mortgage at an APR of 5.731%. Those with credit scores in the 760–850 range applying for the same mortgage could expect APRs around 4.142% for the same loan.
In addition to your credit scores, lenders may also look at your credit history, credit reports, annual income, employment status, other debt, the loan amount and more.
Which lenders offer low interest rates?
There’s no single lender that provides personal loans with low interest rates for everyone. But certain types of lenders tend to offer lower rates than others.
For example, according to a National Credit Union Administration study, the average interest rate for a fixed 36-month unsecured loan from a credit union as of March 2018 was 9.22% versus 10.09% for banks.
Credit unions are not-for-profit financial institutions. So any proceeds that a credit union might earn go toward providing better service for their members rather than to increase profits. Of course, in order to get a loan from a credit union, you’ll typically need to be a member of that union.
Online lenders may also be able to provide lower interest rates than traditional banks, because they don’t have the overhead costs that can come with bricks-and-mortar branches.
But because each lender has a different risk tolerance and underwriting criteria, it’s still wise to compare personal loans from several lenders to make sure you get the best deal available for you.
How to estimate your interest rate before you apply
Many personal loan companies allow you to see if you prequalify for an offer before applying. You usually need to share some basic information about yourself, including your …
- Date of birth
- Social Security
- Contact information
Once you submit the required information, the lender can run a soft credit check to get an idea of your credit history. If you’re prequalified, the lender may share an estimated interest rate and loan amount for your review.
If you like the estimated rate and amount, you can submit an application and the lender will run a hard credit check. This gives the lender a fuller picture of your creditworthiness. The lender will then determine whether or not to approve your application and, if approved, give you a final interest rate and loan amount.
It’s important to note that if approved your final interest rate and loan amount may be different than the estimates you got during the prequalification process. This can happen if the lender finds something through the hard credit check that changes how it views your creditworthiness.
How do soft and hard credit checks differ?
How do soft and hard credit checks differ?
Credit checks, also called credit inquiries or pulls, allow creditors to review your credit file. There are two types of credit checks, each differing in purpose and credit impact.
A soft credit check typically occurs when an existing lender checks your credit, a prospective lender prescreens you for an offer, or when you pull your own credit. Soft credit checks don’t affect your credit scores.
Hard credit checks, on the other hand, happen when you apply for new credit. Many credit scoring models factor in how often you apply for credit. As a result, it can negatively affect your credit scores. Since lenders are often interested in knowing how recently or often you’ve applied for credit cards or loans, a hard credit check can be relevant to your creditworthiness.
Tips for getting the best possible interest rate on a personal loan
If you’re interested in taking out a personal loan, you may want to avoid automatically taking the first offer you see. Instead, consider these three tips.
1. Check your credit scores
As we’ve already mentioned, the higher your credit scores, the better your chances of getting a lower interest rate. To get an idea of what lenders might see, check your TransUnion® and Equifax® credit scores for free on Credit Karma.
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2. Pay down existing debt
One factor that lenders may consider when you apply for a personal loan is your debt-to-income ratio. DTI is generally calculated by adding up all your monthly debt obligations and dividing the sum by your monthly before-tax income.
“Your DTI is an indicator of your ability to reasonably take on — and pay off — more debt,” Allocca says.
If your DTI is high, you might be considered a risky borrower and offered a higher interest rate. So again, if you have time and it makes sense for you, consider paying down some of your existing debt, especially your credit card balances, before applying for a personal loan.
3. Shop around
Since each lender has different criteria for determining interest rates, it’s worth checking rates with several lenders to see which can offer you the best terms.
Allocca recommends comparing yearly costs for different loan options by APR.
“But be sure to factor in costs like fees and early-payoff penalties,” he says. “This will help you avoid falling into common traps by advertisers who emphasize the rate only.”
Allocca recommends checking the fine print with each lender to make sure you have a clear picture of what you’re getting yourself into.
Scoring a personal loan with low interest rates can save you hundreds if not thousands of dollars in interest over the life of your loan.
The more you understand how lenders set interest rates and how you can make yourself a model borrower, the easier it can be to qualify for lower interest rates with a lower monthly payment.