Have you seen an interest rate advertised for a personal loan but you got offered something completely different? Here I explain why this can happen and things you can do to try and get a better rate.
If you are considering taking out a personal loan, the interest rate you get will depend on two main things. First, how the lender prices their personal loans, and second, is your loan secured or unsecured.
Lender personal loan pricing
How a lender ‘prices’ their personal loans is essentially how they work out your interest rate. Lenders typically base this on your risk as a customer, or the alternative is to have a set price for all customers, like home loans, with a one size (price) fits all approach.
Risk Based Pricing
What I mean by risk, is the potential you may have to not repay your loan. As a trustworthy borrower it may be hard to believe, but a significant number of people do not repay their loans. This costs lenders money and so they set their interest rates for this possible risk, hence the appropriately named; Risk Based Pricing. Still with me?
The majority of lenders in Australia use risk based pricing for personal loans, so you get a bespoke interest rate according to your assets, liabilities and credit history – so essentially your ability to borrow and repay your personal loan.
Borrowers are classified in ‘risk grades’, which identify whether you are high, medium or low risk to the lender. Your credit history plays a big part in deciding this. If you have very little or bad credit history, such as having a default where you didn’t pay something owed, you’re likely to be treated as more risky.
Different risk grades will come with a different price, or interest rate. So if you have strong assets versus liabilities and good credit history, you should get the best price, the price you saw advertised because the lender believes you are most likely to repay the loan.
TIP! If you aren’t getting the best rate, you should check your credit history. While you can’t find out what ‘risk grade’ a lender gives you, there a few websites where you can get your credit score for free. You may be surprised that any debt you rack up and don’t pay back, like an unpaid phone bill or video rental fine, can affect your borrowing power!
Set priced interest rates
Some lenders choose to give a set price for personal loans. This is where lenders set the same interest rate for all customers of a specific type, e.g. low risk.
Larger banks are more likely to do this kind of pricing because they generally know more about you than a smaller lender would, especially if you’re an existing customer (think how old you were when you first got a transaction account, that’s how long they’ve known you!).
This means they can see pretty quickly that what you say on the application is true or not, based on the money you have coming in and going out.
Often a customer will either fit the lender’s criteria or not, and if you don’t, then you may be declined even if you aren’t that risky. Smaller lenders can be more flexible, and this is why you may see an increase in the interest rate to match your risk profile.
Secured or unsecured personal loans
There is a difference between unsecured and secured personal loans too, and this will also impact the interest rate you get.
Secured personal loans
Securing a loan against the asset you are purchasing like a car, boat or caravan means the lender has something that they can repossess if anything goes wrong or you fail to make your repayments. This means that the loan is a lower risk to the lender so they are typically more comfortable to offer a lower interest rate.
Unsecured personal loans
With an unsecured loan you don’t leverage an asset to the loan, which means the lender has nothing to claim if you fail to pay. This increases the lenders risk, so the interest rate on unsecured loans is typically higher.
TIP! Personal loans for things like holidays or weddings are normally unsecured, but you may be able to secure an asset against the loan to try and get a lower interest rate. Some lenders will accept security, like your car or another valuable asset, to help you access a lower interest rate.
Generally in the online application you are asked what the loan is for, but it’s worth having a conversation with the lender to ask if you put up security will it reduce your interest rate. It might not be accepted in all instances, but sometimes it will and it could save you up to 2%, possibly being hundreds of dollars at no extra cost to you.
If you are thinking about getting a personal loan, check out these insider secrets on how to get your personal loan approved.
If you recently got a personal loan do you know how your interest rate was determined? Let us know in the comments below.
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