How are personal loan interest rates calculated?
Personal lenders set their own interest rates on their products; however, they are influenced by the official exchange rate set by the Reserve Bank of Australia (RBA).
After its monthly meeting, the RBA will announce whether it has made any changes to the official exchange rate. It could go up, down or stay the same. There are a number of things that influence the rate change, including spending and employment statistics, as well as inflation and economic growth. In order to slow borrowing, economic activity and inflation, the RBA will raise the rate. Alternatively, however, if they want to boost these things, they will reduce it.
Generally speaking, Australian lenders adjust interest rates after the RBA announcement.
What types of personal loan interest rates are there?
There are two types of interest rates for personal loans: variable Where fixed. The rate can influence the amount of your repayments and ultimately the overall cost of the loan. Additionally, there is also the comparison rate to know, which includes not only the overall rate, but also the fees.
Read on to learn more about how each type of interest rate works.
Variable prices:
One option when choosing a personal loan is a variable rate. This type of rate can change during the life of the loan and increase or decrease according to the evolution of the market. Where variable rates come in handy is if the rates are reduced, as you’ll end up paying less interest than when you took out the loan. But it can also work the other way around. If rates are increased, you will face a larger interest repayment than before.
The bonus of a variable personal loan is that you are unlikely to have to pay a prepayment penalty if you pay off your loan earlier than expected. So, a variable option may be right for you if you’re okay with potential changes to your rate and plan to make additional repayments.
Fixed rates:
Alternatively, you can opt for a fixed rate instead. This is where you get the same interest rate over the life of the loan. So, if you are consistent with your regular repayments, you will end up paying the same amount every week, fortnight or month.
The advantage here is that if interest rates are increased, your loan will not be affected because you have locked in your rate. On the other hand, it also means that if rates go down, yours won’t change either. And it’s also important to note that unlike variable rate personal loans, lenders are more likely to charge prepayment fees on fixed options.
What is a comparison rate?
When evaluating different personal loan options, it’s crucial to consider the comparison rate. Unlike the headline rate, it combines both interest and fees that you will also pay.
Under the National Credit Code, it is mandatory for Australian lenders to advertise comparison rates on their products. This is because it is a more accurate representation of what the loan might actually cost rather than just the headline rate. In most cases, the comparison rate is higher because adding fees and charges to the loan makes it more expensive for the customer. It is therefore important that when reviewing potential personal loan products, you ensure that the overall rate and the comparison rate are not significantly different. Because if they are, it means that you will probably face a number of high costs on the loan.
Want a hand to start comparing? Check out the Mozo Personal Loan Comparison Calculator.
Online lenders vs banks: how do their interest rates compare?
When it comes to online lenders versus banks, there isn’t much difference in interest rates. Instead, you should consider how you plan to handle your loan and what your preferences are.
On the one hand, if you like traditional forms of banking, including the ability to visit your local branch, choosing a personal loan from a bank may be more beneficial for you. However, if you don’t mind managing your loan online, evaluate both banks and digital lenders to see who offers the most competitive rates.
How does my credit rating affect my personal loan interest rate?
More and more Australian personal lenders are offering their customers personalized interest rates based on their credit score. This is called risk-based pricing, where interest rates are determined based on how likely a lender thinks the borrower is in default on their loan.
How do you know if a loan offers risk-based pricing? Well, instead of announcing a fare, they will offer a minimum fare and a maximum fare. Based on a customer’s credit history, a lender is able to offer a rate that falls anywhere between the advertised double digits. So to put it simply, those with great credit will get a low rate, and those with bad credit will get a high rate.
While this type of pricing model may seem to only benefit those with good credit scores, it also opens up more opportunities for those with bad credit. As in some cases, lenders who do not have risk-based pricing may deny them the loan altogether.
How can I get the best interest rate on a personal loan?
There are a range of different things to consider when choosing the best personal loan interest rate for you, as well as a number of lenders to weigh up. So be sure to shop around and read the fine print so that the loan you take out fits your budget.
A great place to start is right here at Mozo! We have a range of handy tools to help you:
Also, if you want to learn more about loan products in general, you can check out our loans page or other interest rate guides.
