From home improvements to surprise medical costs, personal loans are great for a majority of uses. But an interest rate is a vital ingredient that plays a huge role in how much your loan will ultimately cost. Your credit score helps to determine the interest rates. Here’s a closer look at how your credit score influences the interest rate on a personal loan and why it matters.
Understanding credit score
The credit score is calculated based on your credit history, your creditworthiness can be represented in numbers. It depicts to the world how responsibly one has handled credit in his previous history based on four key elements: payment history, credit utilisation, credit mix, and length of credit history. A good credit score has less risk for the lenders, which means less amount of interest on credit cards and loans.
- High credit score: You have a low-risk profile for a lender to give you credits if your credit score happens to be high, in most cases above 700 or 750. That means that lenders consider you to pay off the entire loan and back on time.
- Poor credit score: On the other hand, if you have a poor credit score that is less than 600 or 620, then lenders can place you in a higher-risk category. Lending money to you is riskier to them because they may fear you would not repay your loan timely.
The impact of credit score on personal loan interest rates
1. Risk assessment by creditors: A good credit score often above 750 is perceived to mean that previously one has used credit responsibly, and lenders are likely to make sure that they will repay the loan on time. A bad credit score (below 600) implies a higher risk-one likely to face a higher rate or even rejection of the loan.
2. Determining interest rates: Your credit score will directly decide about interest rates offered to you, wherein good scores usually get eligible for more competitive rates reducing your cost of borrowing.
3. Negotiation power: A good credit score provides leverage during negotiations. There are often better terms associated with a score greater than 750, including personal loan rates or flexible repayment conditions.
4. Speed of loan approval: A high credit score not only affects the interest rate one will pay but also expedites the loan application process. A poor score, however, can result in refusal, higher interest rates, or even longer times.
5. Effect on loan amount and repayment period: In addition, your credit score might be used by lenders in determining the loan amount as well as the payback schedule. In most cases, higher scores are associated with larger loan amounts and better repayment terms, which makes it easier to manage the loan altogether.
Why does your credit score matter?
Your borrowing experience is significantly shaped by your credit score:
Conclusion
The interest rates of personal loans are directly proportional to your credit score. However, a good credit score, besides saving you interest costs, increases the chances of getting a loan and gets you better conditions. Developing good habits of credit like making timely payments for bills and keeping the percentage of credit utilisation low will improve your financial condition and lay a solid foundation for a safe and secure financial future.
Before taking personal loans you should always consider advice from any financial advisor, as personal loans generally have higher interest rates compared to other types of loans.
