How to calculate bank interest rates on a personal loan?

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A personal loan provides a convenient way to secure funds without collateral. It is popular for individuals with proper documentation and a favourable credit score.

When repaying a personal loan, you are required to pay back the borrowed amount along with an additional component known as interest. This interest is charged separately and over the principal loan amount.

Let’s explore the intricacies of personal loan interest rates and how they are calculated.

What is a personal loan interest rate?

Banks and financial institutions offer personal loans to individuals for various reasons, such as medical emergencies, debt consolidation, wedding expenses, home renovation, and more. These loans are unsecured, meaning there is no collateral required.

When you take a personal loan, the lender charges you interest on the principal amount borrowed. The interest rate is usually expressed as an annual percentage. It can vary depending on the borrower’s creditworthiness, income, loan tenure, and prevailing market conditions.

How to calculate personal loan interest rates?

Calculating the interest to be paid on your personal loan is essential in understanding the components of your monthly installment. Let’s explore the unique formula to effectively calculate your loan’s EMI and interest amount.

Consider the principal amount and the offered interest rate to compute the interest paid. The interest is a significant part of your Equated Monthly Installment (EMI) and is crucial to your repayment journey.

Here’s the exclusive formula to calculate your personal loan’s EMI and the corresponding interest amount:

Interest paid = (Principal amount × Interest rate) / 12 (Months in a year)

Let’s demonstrate this with an example: Suppose you borrow Rs. 10 lakhs at an interest rate of 11%. To determine the interest for the first month, apply the formula as follows:

Interest for first month = (Rs. 10,00,000 × 0.11) / 12

= Rs. 9166.66

In this example:

Principal amount: Rs. 10,00,000

Interest rate: 11%

Interest calculation period: Monthly (Divided by 12)

Factors used to calculate interest rate

Several factors influence the personal loan interest rate offered by lenders. Here are some factors can help you secure a better interest rate:

Credit score: A higher credit score indicates a lower credit risk, leading to a better interest rate.

Income: A stable and sufficient income enhances your repayment capacity, which can result in a favourable interest rate.

Loan amount and tenure: Larger loan amounts or longer tenures may attract higher interest rates.

Employment history: A steady employment history can positively impact your loan application and interest rate.

Market conditions: Fluctuations in market conditions can influence interest rates.

Relationship with the lender: Existing customers may receive preferential rates based on their banking history with the lender.

To wrap up

When taking a personal loan, it is essential to be aware of the interest rates and how they affect your repayment. Before applying for a personal loan, compare the interest rates from different lenders, and ensure you meet their eligibility criteria to secure the best possible deal.

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