What Is the Average Interest Rate on a Personal Loan (and Why Is It Important)?
When you’re trying to consolidate debt , cover an unexpected expense , or borrow money for a large purchase, a personal loan may be right for you. And, naturally, one of the most important factors to consider when taking out a personal loan is the interest rate. Currently, the average interest rate on a consumer loan ranges from 12% to 13%. However, it is important to note that this figure is only a guideline and individual rates can vary greatly depending on several factors. Let’s take a look at the state of personal loan rates right now and what you can do to get the best rate for your financial situation.
How do consumer loans work?
Personal loans are usually unsecured loans , meaning they do not require collateral. Borrowers receive a lump sum of money from a lender and agree to repay it over a set period, usually in fixed monthly payments. The interest rate on the loan determines how much you will pay in addition to the principal amount borrowed.
Why Interest Rates Matter
The interest rate on a personal loan has a significant impact on the overall cost of the loan. Even a small difference in interest rates can add up to hundreds or thousands of dollars over the life of the loan. For example, for a loan of $10,000 for a period of three years:
-
At 10% APR, you’ll pay $1,616 in total.
-
At 13% APR, you’ll pay $2,135 in total.
That’s a difference of $519, which is quite a difference. A higher interest rate means you’ll pay more interest over the life of the loan, which could potentially add thousands of dollars to your total repayment.
Ideal Interest Rates
Although the average rate is around 12-13%, the ideal interest rate on a personal loan is as low as possible. According to debt lawyer Leslie Thain, the best interest rates on loans today can be found as low as 5% to 6%, although many lenders start their rates at 7% to 9%. Thain says these rates are reserved for the most creditworthy borrowers, or borrowers with a “very good” credit score of around 740 or higher. “These borrowers have demonstrated past behavior that indicates a low level of risk,” Thain explains. “They typically pay their bills on time, maintain low debt balances and do not rely heavily on credit.”
At the other end of the spectrum, borrowers with bad credit can expect to pay more than 30% for an unsecured personal loan. These borrowers have had problems with missed payments and even foreclosures or bankruptcies in the past . “Because of past debt management problems,” Thain says, “they pose a high level of risk to lenders and face subprime interest rates.” Generally, any rate below average can be considered good, especially if it is lower than interest rates on existing debts.
How to secure consumer credit
The process of applying for a personal loan is a little more complicated than simply walking into a bank and asking to borrow money, especially without collateral. Lenders will look at your credit report, credit score, income, employment status, outstanding debt and overall financial situation before deciding whether to approve you for a loan and at what interest rate.
The most common sources of unsecured personal loans are banks, credit unions, and online lenders. Many allow you to start the process by applying online or over the phone. You will need to provide information such as your name, contact information, Social Security number, income, desired loan amount, and what you plan to use the funds for. The lender will then pull your credit report and other financial data before telling you whether you are approved or rejected.
Tips for getting the best interest rate on your loan
1. Check and improve your credit score. Your credit score is one of the main factors that lenders consider. Pay bills on time, reduce credit card balances, and correct any errors on your credit report.
2. Shop around: Don’t settle for the first offer. Compare rates from several lenders, including banks, credit unions and online lenders.
3. Consider a secured loan. If you’re struggling to qualify for a low rate on an unsecured loan, a secured loan (using an asset as collateral) may offer better terms.
4. Find a guarantor. A cosigner with an excellent credit history can help you qualify for a lower rate.
5. Choose a shorter loan term. Shorter terms often come with lower interest rates, although your monthly payments will be higher.
6. Improve your debt-to-income ratio: Pay off existing debts and avoid taking on new ones before applying for a loan.
7. Show stable income. Lenders give preference to borrowers with stable and reliable sources of income.
8. Look for discounts. Some lenders offer discounts to retain existing customers.
Understanding personal loan interest rates and how they affect your borrowing costs is critical to making informed financial decisions. By focusing on improving your credit and diligently shopping for the best rates, you can save a significant chunk of change over the life of your loan.