Personal Loan Cost: Breaking Down Interest Rates with an Example

Sometimes in life, you just need a little extra money. When you do not have time to earn it with a job, you might turn to your credit cards. If that does not cover it, you take out a personal loan.

But, wait. A personal loan? Aren’t those tough to get?

Yes and no.

It can be hard to qualify for a personal loan if you have little to no credit. It also makes it tough if you have bad credit.

That does not mean that you cannot qualify for a loan. It does mean that you will need to look a little harder and apply for a few more loans than someone with excellent credit.

Even those with bad credit can obtain a loan. Okay, not a prime loan, but a loan.

What does it mean for a loan to be prime?

Prime refers to the interest rate of the loan. A prime interest rate refers to the lower, very desirable interest rates.

These interest rates go to prime borrowers. The term prime borrower refers an individual with excellent or very good credit. Their credit score is in the high 700s or low to mid 800s.

Individuals with scores beneath that level receive sub-prime interest rates.

The term sub-prime interest rates refers to the higher interest rates that go to individuals with good, fair and poor credit. Those individuals typically have a credit score of 719 or less.

Determining Personal Loan Cost

Typically, the average annual percentage rate ranges between 10 and 28 percent. These rates change each year. The above rates are for 2019. In some years, they drop as low as five percent. On the other hand, some years they rise all the way to 36 percent.

Other stuff goes into which interest rate you get. It is more than how creditworthy you are. Your credit score does mean a lot, but these other items also go into the formula used to determine your interest rate:

  • the length of the loan,
  • how much money you are asking for,
  • the lending institution.

The greater the amount of money you need, the higher your APR will be. The same is true of requesting a long loan term. That translates to higher risk for the bank because more people typically default on larger loans and those that take a long period of time to repay.

Typical Loan Interest Rates

With really terrific credit and the right loan length plus loan amount, you could currently land a rate as low as 2.9 percent from Backed. You can do almost as well with LightStream which offers a 3.99 percent interest rate when you set up auto pay for your monthly payments. Those rates aren’t typical. You should not expect to land a rate like that. Personal loan cost varies widely.

EXAMPLES

If you have really great credit and the stars are in alignment, you can score an interest rate of 5.99 percent or 6.99 percent. Best Egg, FreedomPlus, Marcus, Payoff, Peerform, PersonalLoans.com, PNC Bank and Upgrade all offer the 5.99 percent interest rate to their best applicants. The 6.99 percent rate you’ll find at Discover Personal Loans, Earnest, Santander Bank and TD Bank.

While many banks and credit unions offer competitive interest rates, you will typically receive the lowest interest rates at online lenders. Online lenders also typically prove more amenable to applicants with lower credit scores. Some will loan to people with scores as low as 580 though the personal loan cost will be higher.

Apply to credit unions that offer alternative lending programs. These typically offer low interest rates to individuals with poor credit scores. As I mentioned in a previous article, these credit unions leverage their not-for-profit status to charge lower interest rates than banks. Next to online lenders, credit unions are the most likely institution to loan you money.

You can put it all on a credit card, if you happen to have an amazing credit score. This could land you a zero percent balance transfer credit card. So long as you can make the payments, you can save money on the interest while the introductory rate remains good.

The Importance of Your Credit Score

I cannot overemphasize how vital your healthy credit score is to you obtaining a good interest rate. While a great score can get you an interest rate in the low, single digits, people with those awesome scores are pretty rare. Most people have fair to poor credit. That’s because as a country, the US has become addicted to credit cards. Our habits, like our blue jeans, have traveled to other countries and now, people the world over struggle with credit burdens.

Since most people have fair to poor credit, they will qualify for the higher interest rate loans. Typically, the interest rates they get fall between 18 percent to 36 percent.

Some lending institutions will turn down applicants with no credit history or a credit score of less than 580 for a conventional personal loan. If this happens, turn to a local credit union or a nonprofit financial assistance organization. Skip the loan sharks and the payday loans. The APR for both borders on ridiculous. Avoid accepting a loan with an interest rate that you cannot afford to pay back.

Personal Loan Cost: Interest Rates by Credit Score
Credit Description Credit Score Interest Rate Range
Excellent 720 – 850 10.3 – 12.5%
Good 680 – 719 13.5 – 15.5%
Average/Fair 640 – 679 17.8 – 19.9%
Poor 300 – 639 28.5 – 32.0%

Personal Loan Costs: Determining What You Can Afford

The smart way to apply for personal loans is to know exactly what you can afford first. That means developing a budget, if you do not already have one and sticking to it. Your budget lets you see what you have on a monthly basis to repay the loan. It has to be enough to cover both the interest payments and the principal every month, ideally with a small cushion. The great thing is that you can actually raise your credit score by taking out the personal loan you need, then repaying it in a timely fashion.

When you apply for personal loans, you have to know how the interest rates affect the amount you pay back overall and on a monthly basis. If you apply and only receive interest rates that are too high for you to make the payments, you need to consider other options. You may have to wait to take out a loan or you may need to acquire it from a private source.

How Do You Know How Much Loan You Can Afford?

Since it is to banks’ and credit unions’ advantage when you repay your loan on time, they provide free tools to help you plan for taking out a loan. These include loan calculators. These vary in complexity and detail. While you might begin your planning phase of your loan search with an easy to use calculator that uses basic information, it is to your advantage to then move on to the complex, more detailed calculator after the fact.

Personal Loan Calculator – Easy to Use

BankRate’s APR Calculator: You need only three simple numbers for this calculator. You can quickly broad brush a few loan scenarios.

Personal Loan Calculator – Complex

Finder’s Personal Loan Cost Calculator: Finder’s much more complex calculator requires between seven and 10 inputs, but it provides you very exact information that lets you build an accurate picture of what you can afford. After using it, you will know what interest rates and loan terms you can accept and still expect to pay them off on time. Taking out too large a loan places you in jeopardy of not being able to repay it.

Lower Your Personal Loan Cost

You can increase your likelihood of loan acceptance and obtain a better interest rate with a few techniques. Some involve your loan search while others involve agreements with the financial lender.

  • Use a co-signer. Backed offers extremely affordable personal loan interest rates, but it requires the borrowers to use a co-signer to qualify for them.
  • Use comparison shopping tools to ease your loan search.
  • Take a second job or side gig. Use the pay stubs from the job to enhance your loan application.
  • Pay down your credit cards while you search for your loan. The less credit you have out, the more likely you are to obtain a favorable set of loan terms.

I talk as if your loan search will take some time. It probably will. Only the tiny percentage of people with exemplary credit can typically qualify for the loan they need on the first try. You should expect to shop around for a loan for at least a few weeks. That includes your creation of a budget, research into interest rates you can afford, the actual loan applications and the loan approval process.

Sure, there are online loans you can obtain and they advertise they will deposit the loan amount directly into your bank account within 24 hours. Some say 48 hours. Those loans prove some of the most costly. They have extremely high interest rates.

Your goal should be to obtain a personal loan that costs a reasonable amount with a loan term that makes it comfortable for you to pay back. Certainly, if you have to have the money, you may have to take what you can get, but you should make the concerted effort to obtain a conventional loan first.

Meeting with a Loan Officer to Reduce Personal Loan Cost

If you have made your loan applications and the interest rates your potential financial lenders provided turn out to be more than you can afford, you still have some more options to reduce your personal loan cost.

Ask for a meeting with a loan officer. During this meeting, the officer will consider your employment status, history and proof of income. They will also consider the employment type: full-time, part-time or self-employment. You will need to submit proof of these income streams in the form of pay stubs or W2s. Typically, they want to see at least six months. You will also need to provide your last tax return.

Some lenders require a minimum household annual income. If you do not meet this criteria, there is no reason to apply. It will only hurt your credit score by creating a hard hit to your credit report, officially referred to as a “credit inquiry.” Depending on the lender, the minimum ranges between $20,000 to $40,000. While credit card applications often take your word for it or reference your credit report, the same is not true of financial lenders for personal loans. Meeting the income minimum does not lower your personal loan cost. It just means you can apply for the loan. You will need to submit proof of your annual income to the lender.

Reducing Personal Loan Cost: Finding the Best Rates

You can use websites called loan malls to make finding viable lenders easier. Two of these are Loanry.com and Cashry.com. Neither site makes loans. Neither site is a financial lender. Both sites simply work like a shopping mall for loans, helping you find personal loans online easily.

Each site lists lenders that make personal loans. Loanry essentially may connect you with lenders that offer more traditional, conventional loans. Cashry focuses  more closely on lenders which make cash loans with a quick turnaround. Which site you use depends upon the type of loan you need.

Loanry works better for finding loans in larger amounts. Cashry specializes in small cash loans and fast loans. Both are effective for personal loan shopping.

At both, you will complete a short, succinct form that requests very basic financial and identity information. This creates a soft inquiry to your credit report. It does not “ding” your credit, so there is no effect on your score. We also partnered with Fiona to make sure we connect you only to reputable lenders. If you’d like to get offers, here’s the form:


And now what?

From this information, the company searches the lenders in its database for those that match your needs. These lenders offer you the closest match to your needs. If you meet the lenders requirements you may get the loan you need. While Loanry and Cashry do not make loans and they do not promise you will get a loan from a lender at their mall, they can make the loan shopping process much easier.

It not only saves you time to use these loan malls, it saves your credit score. The soft inquiry that the loan mall makes does not appear on your credit report nor does it affect your score. It does draw enough information to determine which lenders would be most likely to extend a loan to you.

Using these items to find potential lenders can help reduce personal loan cost. It makes sense to use every Internet tool available and all the credit score enhancing techniques possible to reduce your personal loan cost. Why pay more? It makes no sense. As with anything in life, common sense tells you to look around and find the best deal. This is especially true for finding a personal loan.

What Goes Into Your Credit Score?

Credit score basicsYour credit score and your monthly income comprise the two largest contributing factors to whether and which loan you obtain. While financial institutions examine a number of data points when deciding whether to loan you money, your credit score carries the most weight.

So, what goes into those three little digits that make or break your ability to take out a loan?

The credit reporting agencies look at your credit history, typically going back seven years, your employment status, your income, your extended credit, the number of credit inquires to your account, your payments schedules and whether or not you paid on time. All of that feeds into a formula that spits out a three digit number that defines you as a person to every financial institution.

You aren’t a nice, hardworking individual with three kids and a mortgage. You are 785. To them, that says you do pretty well paying your bills on time. You probably are not late with your payments. And, you might not have made the 800s because you and your spouse took out quite a few credit cards and maxed a few, maybe most, out. You always make the payments though even if you only make the minimums. The bank looks at the credit score, your employment and your debt-to-income ratio.

There’s a classic rock song by Bob Seger that says, “I’m not a number.” Ah, but you are to the banks. You are 785 or you are 665 or 540. Those three digits say so much to the loan officer who sees them. They know what goes into the formula calculations, so they know what is up when they see the number.

They also know that the credit reporting agencies update the number every month. Every month, each credit card or financial institution with whom you have a loan reports to them if you made your payment, how much you paid and when you paid it. They know if you are late by even a day. They are kind of like Santa Claus or God in that sense.

Improve Your Credit Score Fast

7 tips to increase your credit score

That is the bad news and the good news. Just as the bank knows that your credit score reflects an accurate and timely picture of your finances, you can alter the score quickly with a few steps.

Do Not Be Late with Your Payments

First, make your payments on time. Seriously, that’s it. Poof. Your score goes up. Every month you do this, your score goes up. In six months of this, you can increase your credit score by 30 to 50 points.

Check Your Credit Report Regularly

Second, check your credit report. The score plugs into bank formulas for easy calculation. The financial institution also gets a lengthy report that shows exactly which lenders have extended you money and how much and when you paid late or on time.

You can get this same report for free. You read it very carefully and make sure that all the information on it is absolutely correct. Anything that looks hinky or incorrect, you report to the agency. This requires filling out a rather lengthy form online, signing it in blood and providing proof you are really you. I am kidding about the blood. It does take a while to complete, but it is worth it because once you report the inaccuracy the agency investigates. If the information is genuinely wrong, the agency removes it from your report. That typically increases your score.

What kind of things should you question? Definitely any accounts you see that you do not recognize. Yes. This actually happens. Identity theft occurs frequently. You should check your score at least every six months to ensure that your report remains accurate.

Also, check your payment history on each credit card. You might see a report of a late payment that you can prove was made on time. A few years ago, one of the major credit card banks got into major trouble because it was reporting consumers as late because they made a telephone or online payment after 5 pm in the time zone of the main office of the bank. This did not go over well with the government and that bank has since paid reparations of late fees it charged its customers who did, indeed, make their payments on the day they were due. The way the bank was caught was consumers like you reporting to credit reporting agencies the incorrect information which threw up a red flag.

Consolidate

Third, consolidate those accounts. You can pay them off much more quickly if you consolidate using either a consolidation loan or a non-profit agency that offers bundling of your credit accounts in exchange for making the payments through them.

Dave Ramsey quote

Explaining the Debt-to-Income (DTI) Ratio

Your debt-to-income (DTI) ratio also contributes to your personal loan cost. Financial lenders use this to evaluate applicants. The DTI ratio refers to the amount of debt you carry compared to your pre-tax monthly income. This includes all debt, so your house payment or rent counts. Lenders like individuals with a DTI of less than 45 percent. That lets them know that you have plenty of disposable income.

Let’s say you have a monthly pre-tax income of $4,000. Housing, plus your other loans and credit cards comprise a monthly total debt payment of $1,200. Divide your debt payment by your pre-tax income to get your DTI.

1200.00/4000.00 = .30 or 30 percent

Final Thoughts

Whatever the reason you need the loan, whether it is an emergency medical procedure, a vehicle purchase, your wedding or something else entirely, bringing down your personal loan cost makes good financial sense. With a little work, you can obtain the funds you need at a loan term and interest rate you can easily repay. Start by creating your budget, then conducting research on interest rates you can afford. Finally, use Cashry or Loanry to find potential lenders, then apply. You might need to request a meeting with a local loan officer, but this can help you get a better interest rate and that, ultimately, creates a more amenable personal loan cost.