Before taking out a such a loan, however, it’s important to know:
- What factors affect your loan rate?
- How the interest rate affects your credit score and repayments?
- What to look for to get the best rates?
How Credit Scores Affect Rates
Personal credit is by far the biggest factor when it comes to getting a loan, followed by the type and length of the loan, as well as the type of lender.
Expect average rates for a personal loan range to fall between 10% and 28%. If you have good credit (a score of 720 to 850), your personal loan rate will be low, with an APR of between 10 to 12%. If you have a credit score of less than 580 or no credit history, however, you may not qualify for a traditional personal bank loan. People with poor credit can explore alternative options, such as online personal loans for bad credit, secured, or co-signer loans.
Taking out a personal loan can also affect your credit score, but not by much. When you apply for a personal loan, you make an inquiry that is part of your credit report. According to FICO's website, this only affects your credit score by about 5 points. Your credit is impacted significantly more by applying for many loans within a short time period, with the exception of auto, mortgage or student loans.
What Else Affects Rates?
Type of Loan
When calculating loan rates, lenders also take the type of loan into consideration. For example, secured loans that are backed by collateral, such as a house or car, have cheaper rates, whereas unsecured loans are usually more expensive. Lenders take a higher risk with unsecured loans as they are unable to sell your home or car property in the event of non-payment.
Signature Loans: The most basic type of unsecured loan is a signature loan, which is only secured by your signature. These are installment loans where you pay a fixed amount over a set period of time. Signature loans are available at banks and credit unions, and often have a low interest rate if you have good credit.
Credit Cards: Another common type of unsecured loan is a credit card, which allows you to borrow money when you need it once you are approved. The downside is that it can be easy to rack up a big debt, and interest rates are usually higher than traditional loans.
Student Loans: Student loans are another type of unsecured loan with special payment options, grace periods and interest rates - available sometimes even if you don’t have good credit. To be eligible for this type of loan, however, you need to be a student.
Secured and Unsecured: While unsecured loans are usually used for smaller amounts, secured loans are bigger loans, the most common of which is a mortgage. Home equity and vehicle loans are additional types of secured loans.
Other types of loans are fixed or variable type loans. The interest rate for fixed rate loans remains the same the entire lifetime of the loan, whereas variable rates can change, although they may have a limit to how much they can fluctuate.
Length of Loan
The length of the loan also affects the interest rate. As a rule, the more time you take a loan out for the higher the interest rate will be. While you may pay less each month for a long-term loan, you’ll pay a much higher interest rate. Choosing a shorter-term loan can help minimize the interest on your repayments.
The exception to this is unsecured short-term loans, such as payday loans, which offer quick cash, but can have interest rates of between 300 and 500%.
Type of Lender
The type of lender can also influence rates, which can vary by lender even for individuals within the same credit score range — so it pays to shop around. Personal loans are available through your bank, credit union, or various online lenders. Banks and credit unions have lower interest rates but stricter requirements to meet in order to get a loan. Online lenders may be more flexible with their requirements in exchange for higher interest rates.
How to Compare Personal Loan Rates
While banks and credit unions offer competitive rates, online lenders have also stepped into the marketplace, offering even lower rates. In addition to comparing the APR of different loans, consider whether the interest rate is fixed or variable, and other fees such as penalties for early payments. The higher the interest rate, the higher the cost of lending, and the more you end up paying for your personal loan. Since repayment of the loan on time is vital to your credit score, it’s important to make sure the interest rate will remain the same for the entire duration of the loan. For this reason, it’s best to find a loan with a fixed interest rate, so you can repay the loan in fixed installments over time. You’re also better off repaying loan as quickly as possible to avoid extra interest, which you pay with each installment. Open loans can also affect your ability to get approved for credit cards and additional loans. Be advised that some loans have a prepayment penalty.
The best personal loan is generally the one with the lowest APR and a fixed interest rate. If you have poor credit and are not eligible for a traditional loan, alternative options are available. When choosing which personal loan provider to go for, make sure to shop around for rates that suit your specific needs because you don't want any future surprises in your payment plan – and your credit score.