What are the factors that determine the interest rate that you pay on your loan?

It is important that you have a clear idea about the factors that determine the interest rate that you pay on your personal loan, gold loan or business loan. The first of these factors is the prevailing benchmark interest rate. This prevailing benchmark interest rate is determined by the monetary policy of the central bank.

The higher the prevailing benchmark interest rate, the more will be the interest rate that you pay on the loan that you take. The lesser the prevailing benchmark interest rate, lower the interest rate that you will pay on your loan.

The second factor is your credit risk. Credit risk is the risk that you will default on the interest or principal payments on your loan, when they become due. Your credit risk is determined by your income, your profession or business, your credit history and existing assets. The higher your credit risk in the eyes of the lender, the more the interest rate that you will pay on your loan, and vice versa. The lender compensates itself for your higher credit risk by charging a higher interest rate on the loan. Your credit history or CIBIL score is also used by lenders for determining your credit risk. If you have a good credit history and high CIBIL score, then your credit risk is assumed to be lower. Credit history means your payment record on past loans that you took. Lenders share the credit history of each borrower on the common CIBIL database.

Another factor that determines the interest rate that you pay on your loans is the value of the collateral that you put against your loan. If the value of the collateral is high in comparison to the value of the loan that you have taken, then you will have to pay a lower interest rate. On the other hand, if the value of your collateral is low in comparison to the value of your loan, then you will have to pay a higher interest rate on your loan. In unsecured loans, where you do not put any collateral, you pay higher interest rates.

The term of the loan that you are taking is also a factor that determines the interest rate that you pay. If the term of the loan is longer, then the interest rate is also higher. If the term of the loan is shorter, then the interest rate that you pay on it is also lower. The risk of the lender increases with increase in the term of the loan. So it increases the interest rate with increase in the term of the loan.