Personal loan interest rates - what you need to know

• What are interest rates on personal loans?
• Why are interest rates important?
• What are lenders acceptance criteria?
• How can you improve and get reasonable rates?

What are interest rates on personal loans?

The interest rate on a personal loan will be presented as a percentage. The percentage is a proportion of the amount borrowed. You will be required to pay back both the initial loan amount and the interest rate presented.

What do you need to look out for when exploring the world of loans?

We will first start with the UK national average, which was below 12 percent as of March 2021. On average, personal loan rates are from 10 percent to 28 percent – which is highly influenced by the wider economy, inflation rates and the demand for new lines of credit from borrowers. Within the current economic climate - these rates may vary depending on the personal circumstances of the borrower.

In parallel, the Annual Percentage Rate (APR) includes not only the interest rate (as previously mentioned) but also any additional fees or finance charges. Now, in the scenario where there is no additional charge - the APR will equal the interest rate figure. Check the APR on any personal loan to ensure that you understand all the costs associated with the money you are looking to borrow.

Top Tip: Be aware of all the costs associated with any loan you want to access. The devil is in the detail, and you need to make sure that you are aware of the commitment you are signing up to. In some cases, short term loans can have APRs as high as 1,416.9%. We will explore how you can get the best rates and avoid loans that significantly impact your finances. In most cases, individuals who access short-term loans need the money due to an emergency that has impacted their livelihoods.

Unfortunately – this means the individuals in crisis are provided with unfavourable loan terms and high APRs.

There are alternatives to payday loans, such as a bank overdraft, pay advance or a credit builder credit card; it is essential to research the different options available to you before applying for any credit.

Why are interest rates important?

Well, the fact is that if you are paying higher APRs and interest rates, you are paying more money over the lifetime of the personal loan to have the privilege of obtaining the borrowed money. Remember to factor in the loan repayment term when working out how much you will repay to a lender, as a longer-term will usually mean a more considerable repayment sum.

Let’s use an example to show you the difference between two loans borrowed over the same period and for the same amount of money. in example B, the total interest paid is higher over the course of the loan due to the higher additional fees and the increased interest rate.

What are lenders’ acceptance criteria?

To get the best rates on borrowing, you first need to understand what lenders are looking for in potential borrowers. Lenders carry out checks on each candidate to ensure that they have accounted for the level of risk of the borrower. Those individuals with a higher level of perceived risk will gain less favourable rates and, in some instances, will not be accepted for the personal loan. The ideal candidate will score well across the following checks:

Credit Score - Lenders are looking for individuals with a high credit score as this score is derived from your financial history and background. An individual's credit score provides key data to the lender to allow them to carry out a risk profile on you. It’s important to understand what is a good credit score before taking out any loan. In the UK, there are 3 main credit bureaux, this will also need to be factored in as credit scores may differ between providers. This is crucial to making sure you are offered a low rate on your lending.

Employment – A key risk factor that lenders account is your current employment status. Lenders deem those individuals in full-time employment as presenting the lowest risk profile.

Income – Lenders will factor your income and expenses into the loan decision to ensure that you can meet the loan repayment terms. These affordability checks will allow the bank or independent lender to understand how much free cash flow you possess and the likelihood of any default on a loan.

Debt-to-Income Ratio - Banks will look at loans that have been taken out by a borrow and consider these when making their affordability checks.

Loan Amount – A Loan amount is determined by the volume amount desired, this will in turn reflect the level of interest rate applied. This is again due to the perceived level of risk to reward for the lender.

Loan Term – The loan length will also impact the interest paid over the total loan period. In most cases, the longer the term – the more the borrower will pay in interest to the lender. "Pay Day Loans" commonly come with high APRs due to the risk profile that a lender associates with borrowers perceived as being in a financial crisis. Short-term loans with bad credit can often lead to even higher interest rates, and unfortunately, those in crisis are often plagued with bad credit scores. But no fear, we will use methods to improve your credit score shortly!

Collateral – Where separate assets back up a loan – a bank will deem the loan as less risky and will provide more favourable interest rates. They view these individuals as less risky due to their ability to sell the assets used as collateral.

Guarantor – In some cases, a guarantor scheme may be implemented where an individual will agree to pay the full amount if the borrower fails to pay. In this scenario, the guarantor will be liable for the full amount and, before the loan is provided, will be reviewed under the same risk profile checks. If a personal loan is unsecured, the lender's risk will be more significant, and the interest rate will be higher.

Benchmark Rates – Lenders will also benchmark against national averages. These are publicly available to allow financial institutions to evaluate the cost of borrowing in different markets.

At the start of 2022, the Bank of England’s Monetary Policy Committee (MPC) decided to raise the benchmark rate from 0.25% to 0.5%, meaning that the costs of borrowing money will increase. The rise will primarily affect those who have decided to borrow money with no fixed interest rate. Lenders will add the additional cost to repayments as per the variable interest rate agreement.

For more information on everything to do with personal loans in the UK, check out our online guide.

How can you improve your credit score and get a personal loan with a low-interest rate?

For the best chance to gain an offer of favourable rates, you should aim to be as close to the ideal candidate as possible through the criteria listed above. Improving your credit score is a significant first step in making sure you can get the best rates possible. A good credit score range, according to Experian, spans from 881 to 960, Equifax spans from 531 to 810, and TransUnion spans from 604 to 627, increasing your score to these margins is a great way to make sure you are in the best possible position possible. You can do this through credit score monitoring tools that will show ways to improve your credit score. There are free credit reports in the UK. So it's worth spending time to compare credit reports providers and check if it's worth paying a fee. If you find yourself with a low credit score, you may have to use alternative methods to gain personal loans with bad credit.

While you work to increase your credit score, you can make sure you are comparing the most favourable rates after you have inserted your details (checked against the criteria above). With personal loan comparison websites, you can browse a range of personal loans suitable to your requirements while ensuring you get the best deal with the lowest APR and interest rates. The best part about comparison sites is that they are free in today's interconnected world – Don’t miss out on the latest tips and guidance.