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Interest Rate Ranges: How is Your Rate Determined?

Jul 27, 2022 | Insights

A commonly asked question during the loan application process is “what will my interest rate be?”

Interest rate curiosity is understandable, given that the range offered by lenders can vary. Where you fall on the interest rate scale will come down to a number of different factors — perhaps more than meets the eye.

Smart financial decisions start with understanding; that’s why we’re helping you uncover a mountain of different factors that determine personal loan interest rates!

What is an interest rate?

In case you’re new to the world of borrowing money, or simply want a refresher, we’ll first bring you up to speed on what an ‘interest rate’ is.
Interest rates work differently depending on whether it’s for saving or borrowing; either as a financial ‘reward’ for saving or investing money, where the bank or financial institution pays you interest on your money, or as a ‘cost’ to borrowing funds, where you pay interest to the bank, credit union or lender on the money you’ve borrowed.
Interest is usually quoted as an annual percentage rate of the money you’re borrowing or investing. For example, your financial product may say ‘5.00% interest per annum (pa)’ which means ‘per year’. However, interest is not just charged or paid once a year, and might be calculated on either your monthly or daily balance, and charged weekly or monthly.

When you are being paid interest, that rate is based on the cash rate set by the Reserve Bank of Australia (RBA). When you are charged interest however, that rate is set by the lenders themselves, but can be influenced by what the RBA does with cash rates!

What determines interest rates?

When you look to borrow money, you’ll probably soon realise that most advertised interest rates are over a range, which show the minimum and maximum rate you might be charged on that loan product. This is where some people can become curious as to why the range is so large.

There are a lot of determining factors when it comes to figuring out how much to charge in interest on credit accounts and products, particularly home loan interest rates,and personal loan interest rates which can include a car loan, boat loans, and unsecured loans. For lenders (including banks and online lenders) lending out money comes with some risk — the risk that the borrower may not be able to pay the loan back. Interest payments can help to mitigate this risk which is why one of the main factors to determining your interest rate is your own financial situation and credit history.

At Finance One, we take a personal approach when it comes to assessing your application

We look at your full situation and may be able to help out even if you have a low credit score, bad credit history or if you don’t quite fit the mould for the traditional lending criteria.

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Your credit rating

When you apply for a loan, every lender with an Australian Credit Licence will need to review your credit report to help them assess how creditworthy you are. For this reason, your credit file plays a huge part in determining your personal loan interest rate. Loan applicants with a good credit score will generally be offered lower interest rates than those with low credit scores because they are deemed to be less risky to lend money to. Being charged less interest means paying back less money over the loan term and potentially having a more affordable monthly repayment, which is why it’s often desirable to have a low rate.

Credit scores and your credit history play a huge part in determining what your interest rate might be, so it pays to understand your credit score.

Your personal details and financial situation

Some of the other factors that help determine your loan rate are your personal details such as your age, annual income, employment position, your debt-to-income ratio (which is your total monthly payments divided by your gross monthly income), whether you’re renting or own your own home, and even the conduct on your transaction accounts!

Loan options

The personal loan options that you can choose when applying for a loan can also influence the final rate of interest. These include:

Your loan amount

Larger loan amounts may sometimes affect your rate, as they could be deemed as more risky than taking out the minimum loan amount (for example) or on the flip side, the lender may prefer to set higher interest on lower amounts to make sure it’s worthwhile for them to lend the money out.

Your loan term

Loan terms for personal loans usually range anywhere from one year up to five or even seven years. The loan term may affect how much interest you’re charged.

Fixed Rate vs Variable Rate Personal Loans

With a fixed rate loan, the rate of interest is ‘fixed’ (that means it won’t change) over the life of the loan. A fixed interest rate provides more certainty to you about how much is going to be repaid (as your monthly payments remain consistent). However, variable rate loans, where the interest rate is subject to vary over the loan term, means that the lender may miss out on increasing your rate throughout the term of your loan, subject to interest rate changes.

Unsecured loan vs secured loan

Security on loans means that you offer up something of yours (i.e. a suitable asset or form of security) that the lender can re-possess if you can’t pay back your loan. Auto loans are a great example of this; you get a car loan and use the car as security, so in essence the lender could look to sell the car and recoup lost funds if you fail to repay the loan.
Unsecured debt leaves the lender with few options to recover their funds in the instance that you default on your loan. To compensate for this additional risk, the interest rate on unsecured loans is typically higher than that of secured loans.

Comparing personal loans

Comparing personal loans to find the best personal loan for you would naturally be one of your personal objectives. Often when you compare personal loans, you would use the comparison rate, which shows the estimated interest rate and any ongoing fees.
Lenders showcase their personal loan offerings via comparison rates, but what the comparison rate can fail to show is:
  • Multiple lenders have strict criteria for lending money and they may not cater to applications for those with a poor credit score.
  • Whether you can pay off your loan early, and if so, whether early exit fees apply.

Good to know

Finance One doesn’t charge any early repayment fees for paying out your consumer loan early.

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The downsides to looking at the average personal loan interest rate

The average interest rate on a personal loan would take into account everyone who currently has a loan, which includes those with an excellent credit history. For that reason, basing your budget on average personal loan rates could feel misleading if you’re applying for a loan with a blemished credit past.

Finance One Personal Loans

Within the finance industry, the criteria set by personal loan lenders can be incredibly steep. If your personal circumstances have led you to have poor credit, accessing a personal loan can feel too big of a climb. Thankfully at Finance One, we take a personal approach when it comes to assessing your application – we look at your full situation and may be able to help out even if you have a low credit score, bad credit history or if you don’t quite fit the mould for the traditional lending criteria.

Before applying elsewhere, speak to the Finance One team to see if we can help you apply for a personal loan with the best interest rate for your situation!

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Disclaimer: The information above is of a general nature only and does not consider your personal objectives, financial situation or particular needs. You should consider seeking independent advice regarding your legal, financial, taxation or other needs, to check how the information relates to your particular circumstances. We do not accept responsibility for any loss arising from the use of, or reliance on, the information. All loan applications are subject to normal lending criteria. Fees and charges payable. Terms and conditions apply.

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Makala Elliott

Makala is the Marketing Manager at Finance One. She has worked in the Finance and Lending industry for over 10 years, gathering a wealth of experience. She is passionate about helping Australians get back on track with their finances by passing on her knowledge.

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