How a risk-based personal loan could benefit you

Ever heard of risk-based pricing or personalised interest rates? Well, if you’re on the hunt for a personal loan it may be something to get familiar with.

Risk-based pricing refers to the interest rate that a bank or lender offers a customer, based on their credit rating. And it’s becoming more popular among Aussie personal loan lenders. 

“It’s really taken off in the last 10 years or so,” Mozo Banking Expert, Peter Marshall says.

“It used to be quite rare but as more and more information is getting put on people’s credit files, more lenders have decided to use that deeper information to inform their pricing, so it has become a lot more common now.” 

How does risk-based pricing work? 

As the name indicates, risk based pricing is calculated based on how much risk the potential borrower poses to the lender. 

David Norman, chief operations officer of online personal loan lender NOW FINANCE, explains that with risk-based pricing, customers receive an interest rate that is tailored to their credit and financial situation. This is instead of the traditional “one-size-fits-all” lending model where there is a single advertised interest rate which everyone gets.

“Lenders calculate personalised interest rates algorithmically, taking into consideration a customer’s unique circumstances,” he says.

“At NOW FINANCE, we have built a proprietary machine-learning pricing engine that uses a person’s credit score, postcode, and employment and residential statuses to determine their guaranteed personalised rate.”

Instead of having a settled interest rate, risk-based personal loans products are advertised with a minimum and maximum loan rate. The lender can offer borrowers any rate between those two numbers, based on a customer’s data.  

Simply put, if the lender views a borrower as “low-risk” they offer them the lower rate. However, if a customer falls on the other side of the fence and is deemed “high-risk”, by having a lower credit rating, the lender offers the higher interest rate. 

But risk-based pricing isn’t only beneficial to people with good credit history

While it might seem that these types of personal loan products are designed just to benefit customers with excellent credit, this is actually not the case. 

“There’s also a benefit to borrowers that might have a low credit rating, because a lot of lenders who offer a single rate may have tighter criteria about who they will give that rate to,” Peter Marshall says. 

“Borrowers with a low credit rating might find themselves locked out of some lenders based on that criteria.” 

Marshall explains that these loans provide particular consumers with an opportunity to borrow who otherwise may not have been eligible. Risk-based loans are also a good way for customers to rebuild their credit rating if it isn't looking healthy at the moment. Or they can help a particular customer establish a credit history if they haven’t done much or any borrowing before. 

“Having the option, even if it is at a higher cost, to borrow money can actually help to rebuild your credit rating. Just as long as you can pay your loan back over time and meet all of your repayments on time,” Marshall says. 

“Say you take out a personal loan now, and you have a not-so-good credit rating, you can use that as an opportunity to rebuild your credit rating. It will help you when you want to borrow more money for something like a home loan because you are more likely to qualify for a loan.” 

Marshall also stated that most of these risked-based loans have variable rates. He says that for customers that do end up on a higher interest rate, they should initially try and make extra repayments to pay off the loan quicker. Not only will this go towards building up your credit rating but it will also mean that you’ll end up paying less in interest. 

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