What affects interest rates on consumer loans?, Money News

When we were kids, borrowing money was easy. You ask your friend if you can borrow $5, he will give you cash from his Hello Kitty wallet, and maybe the next day or next week you will pay the amount back.

Now the process of borrowing money for adults is a little more complicated.

A personal loan is when a bank or lender gives you money for whatever you need, such as sudden emergencies or to pay off credit card debt. You pay it back in monthly installments, plus a small additional fee for borrowing cash. The latter is called interest.

All personal loans will come with interest, so there is nothing personal about it. But it can certainly get complicated. Here are five things that affect your personal loan interest rate.

1. Interest rates applied to the interest rate compared to effective interest rates

When you look at consumer credit information, you’ll see two percent.

The lower percentage represents the applicable interest rate. This advertised rate is displayed by lenders to attract borrowers; this is the basic annual cost of borrowing.

The higher rate is the effective interest rate (EIR), which shows the true cost of taking out a loan. It includes all additional fees and charges, and also takes into account the cumulative effect depending on how often you make payments. So while the advertised rate makes the loan look cheaper, the EIR helps you see the actual amount you’ll actually pay.

When comparing personal loans, it is much more important to look at the EIR. But how to calculate this? Good news: you don’t have to. In Singapore, lenders are required by law to publish an EIR.

This, of course, does not mean that you should ignore everything else and make a decision based solely on the EIR. Read on to learn more factors to consider.

2. Fees

Although the interest rate reflects the cost of borrowing, it is not the only cost. You will also have to pay a number of fees, including a processing fee, annual fee, late payment fee, full repayment fee and restructuring fee.

Of these, the first two are most applicable; the rest only apply if you fall behind on payments or change the terms of your loan. We’ll look at them all further below.

Processing fee

A personal loan processing fee is a one-time charge from the lender to cover the administrative costs of processing and approving the loan. This could be a lump sum, fixed amount, or a percentage of your loan.

For example, an OCBC ExtraCash loan incurs a processing fee of $100 (fixed amount), while a DBS personal loan processing fee starts at one percent of the approved loan amount.

There are also a large number of personal loans that don’t charge any processing fees, including Standard Chartered CashOne, Trust Instant Loan and UOB Personal Loan.

Annual fee

Just like credit cards, there are annual fees for personal loans. This is the annual cost you pay to keep your loan active. Unfortunately, unlike credit card annual fees, personal loan fees usually cannot be waived by contacting your bank.

On the other hand, not all personal loans charge an annual fee. For example, CIMB Personal Loan has an annual fee of $0, while Standard Chartered CashOne has an annual fee of $199 for the first year. Thereafter, it will be $0 unless you pay the minimum monthly payment by the due date – if you do, you will be charged $50.

Late payment fee

You will owe money to your lender if you miss a loan payment or pay it late. However, this is not just a one-time fee – you will also be charged late fees (interest).

A late payment fee is a flat additional fee you pay if you miss a loan payment when it is due. By comparison, late fees are additional interest charged for each day a payment is late, increasing the longer you wait for payment. These late interest rates usually have very high rates, so avoid them at all costs!

For example, if you’re late on your Standard Chartered CashOne loan, you’ll pay a $100 fee on top of an additional interest rate of 29.9 percent per annum (0.082 percent per day).

It can also be one without the other – for example, GXS FlexiLoan does not charge a late fee, but does charge late payment interest at a rate of 18 percent.

Penalty for full repayment

You’ll see different terms for this fee, such as “early termination fee” or “early repayment fee.” But they all refer to the same thing – the fee you pay if you decide to pay off the entire loan before the agreed-upon end date.

This full repayment fee may be interest or a fixed rate. For example, the early repayment fee is three percent for a Trust instant loan and a flat $250 for a DBS personal loan.

The fee can also be either a percentage or a fixed fee, in which case the higher cost will apply. For example, a UOB personal loan charges $150 or three percent of the outstanding loan amount, whichever is higher, and a CIMB personal loan charges $250 or three percent of the outstanding amount.

Restructuring fee

This is a fee for adjusting the loan term – reducing or extending the repayment period of borrowed funds. While the Trust Instant Loan has a restructuring fee of S$0, for loans like Standard Chartered CashOne the fee is S$50 per change.

As I mentioned at the beginning of this section, late payment fees, full repayment penalties, and restructuring fees only apply in certain circumstances.

By comparison, processing fees and annual fees (if your loan has them) will always apply, even if you don’t have any late payments or change your loan term.

For this reason, processing fees and annual fees will be taken into account when calculating the effective interest rate, but others will not. However, other types of commissions are still worth considering; If loan terms change, these fees will be added to the total cost of the loan.

3. Loan term

The length of the loan term (also known as the loan term) refers to how long you will have to repay the loan. This can affect the interest you pay in several ways.

Applicable interest rate

Banks may offer you higher or lower interest rates depending on the length of the loan period you choose. For example, with a Citibank Quick Cash loan, you get higher interest rates for shorter loan periods and lower interest rates for longer loan periods:

However, in the example above, you will notice that the EIR is the same for everyone.

The total amount of interest you pay

Even if the applied interest rate is the same for loans with two different loan periods, and even if there are no annual fees or processing fees, the effective interest rate for both loans will be different.

The Standard Chartered CashOne loan is a good example. Excluding the annual fee, the interest rate on a $20,000 loan is 2.88 percent per year (5.27 percent effective interest rate per year) for the loan term of one year and 2.88 percent per year (5.43 percent per year). effective interest rate per year) for a loan term of five years. years.

You will notice that the EIR increases. This is because with a 5-year loan, interest applies over more periods, meaning you pay more in total interest (even if each individual payment is less). Your interest increases, causing your effective interest rate to rise slightly.

If you want to reduce the cost of your loan, you may want to choose a shorter loan term. Not only will the effect of compounding interest be reduced, but you will also potentially pay less in annual fees.

((id:704292))

4. Your credit rating

Although banks and lenders post their interest rates online, the actual interest rate you’ll be offered depends on other factors, such as your credit score.

Your credit score shows how well you’ve managed money and payments in the past, based on payments such as credit card bills and mortgage payments. Essentially, this is a number that tells you how well you are paying back the money you borrow.

If you have a high score, lenders consider you responsible and may offer you a lower interest rate, meaning you’ll pay less extra money. If your score is low, lenders may think it’s riskier to lend to you and may charge you a higher interest rate, making the loan more expensive.

While your credit score affects the interest rate you’re offered, don’t forget that it works the other way around: How timely you repay your personal loan will also impact your credit score.

((id:706816))

5. Your income profile

While your credit score shows how well you’ve handled money and payments in the past, your current income profile reflects your ability to handle payments now.

Your income profile is essentially how much money you make and how stable your job is. If you have a high income and a stable job, lenders believe that you will be able to repay the loan. They may offer you a lower interest rate, meaning you pay less extra money.

But if your income is lower or your job is unstable, lenders may think it’s riskier to lend to you—you’re more likely to have trouble making your monthly payments on time. They may charge a higher interest rate, making the loan more expensive.

What does this mean to you? If you want to get better interest rates, you should avoid applying for a personal loan while you’re between jobs. It is best to apply after you have found a full-time job.

However, don’t worry if your work is commission-based or you are self-employed. Many banks, including Standard Chartered and DBS, will still consider you eligible for a personal loan as long as you meet the $20,000 annual income requirement.

6. Conclusion

We’ve discussed five factors that affect the interest you pay when taking out a personal loan. Of these five, the most important point is to understand the difference between applied and effective interest rates. Don’t let the advertised rates fool you!

Once you understand what interest rates mean, look out for hidden fees. Banks are reluctant to advertise their processing fees (unless they are $0), so be careful.

Be sure to carefully consider the length of the loan term. To reduce the total interest you pay, take out a shorter loan, but don’t forget that this also means you pay higher repayments each month. Find a realistic balance that you can work with to lower your borrowing costs while also ensuring you don’t have to pay late fees.

((id:658314))

This article was first published in MoneySmart.