How are personal loan interest rates calculated?
Personal loan lenders set their own interest rates on their products, however they are influenced by the official cash rate set by the Reserve Bank of Australia (RBA).
After its monthly meeting, the RBA will announce whether they have made changes to the official cash rate. This could be increasing, decreasing or keeping it the same. There are a number of things that influence the shift of the rate, including spending and employment stats, as well as inflation and economic growth. In order to slow borrowing, economic activity and inflation, the RBA will make the rate higher. Alternatively however, if they want to stimulate these things they will lower it.
Generally speaking, Australian lenders adjust interest rates after the RBA makes its announcement.
What types of personal loan interest rates are there?
There are two types of personal loan interest rates: variable or fixed. The rate can influence how much your repayments are and ultimately how much the loan will cost you overall. Plus, there is also the comparison rate to be aware of, which encompasses not only the headline rate but fees as well.
Read on for a deeper look into how each type of interest rate works.
One option when choosing a personal loan is a variable rate. This type of rate can change over the life of the loan, and move up or down as the market moves. Where variable rates are handy is if rates are slashed, as you’ll end up paying less in interest than when you took out the loan. But it can also work in the opposite way, if rates are hiked up you’ll face a larger interest repayment than you did before.
The bonus of a variable personal loan is that you are unlikely to be charged an early repayment penalty if you pay off your loan ahead of schedule. So a variable option may be right for you if you are okay with potential changes to your rate and plan to make additional repayments.
Alternatively, you could go for a fixed rate instead. This is where you get the same interest rate over the whole duration of the loan. So, if you are consistent with your regular repayments, you’ll end up paying the same amount each week, fortnight or month.
The benefit here is that if interest rates are increased, your loan won’t be affected as you’ve 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, on fixed options lenders are more likely to charge an early repayment fee.
What is a comparison rate?
When weighing up different personal loan options, it’s crucial to consider the comparison rate. Unlike the headline rate, it combines both the interest and fees you will pay as well.
In accordance with the National Credit Code, it is a requirement that Aussie lenders advertise comparison rates on their products. This is because it is a more accurate representation of what the loan might actually cost, rather than the headline rate alone. In most cases, the comparison rate is higher as the addition of fees and charges on the loan make it more costly to the customer. So it’s important that when you are looking at potential personal loan products, you ensure the headline rate and comparison rate aren’t extremely different. Because if they are, it means you’ll likely face a number of hefty 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’s not much difference in interest rates. Instead you should consider the way you plan to manage your loan and what your preferences are.
On the one hand, if you like traditional forms of banking, including the option to head to your local branch, choosing a personal loan from a bank may be better for you. However, if you don’t mind managing your loan online, weigh up both banks and digital lenders to see who offers the most competitive rates.
How does my credit score affect the interest rate of my personal loan?
More and more Australian personal loan lenders are offering customers customised interest rates based on their credit score. This is called risk-based pricing, where interest rates are determined in accordance with how likely a lender thinks the borrower is to default on their loan.
How do you know if a loan offers risk-based pricing? Well, instead of advertising one rate, they’ll be a minimum and maximum rate on offer. Based on a customer’s credit history, a lender is able to offer a rate that sits anywhere between the two numbers advertised. So, to put it simply, those with excellent credit will receive a low rate and those with poor credit will receive a high rate.
While this type of pricing model may sound like it only benefits those with a good credit score, it actually opens up more opportunities for those with bad credit, too. As in some cases, lenders that don’t have risk-based pricing may deny them the loan all together.
How can I get the best interest rate on a personal loan?
There’s a range of different things to consider when choosing the best personal loan interest rate for you, along with a number of lenders to weigh up. So make sure you shop around and read the fine print so that the loan you sign up for fits in your budget.
A great starting point is right here at Mozo! We have a range of handy tools to help you:
Plus, if you are after more on loan products in general you can check out our loans page or more interest rate guides.