How interest rate you have to pay on your loan is determined

There are many factors that affect the interest rate that you have to pay on a loan such as credit scores, collateral and so on.

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Competition pricing in terms of what the other lenders are charging for the same facility also determines the interest rate.
1. Credit scores are taken into account while setting interest rates and the borrower with a better score gets a lower interest rate on a loan.

2. When a loan is secured by collateral, the risk of default by the borrower decreases and hence the risk premium charged may be lower, reducing the rate of borrowing.

3. The shorter the tenor of the loan, the lower the risk, since the ability of the borrower to repay the loan is less likely to change and hence lower the rate of interest.


4. Loan pricing also takes into account the conduct of accounts in past year in terms of regularity of repayment for repeat borrowers.

5. Competition pricing in terms of what the other lenders are charging for the same facility also determines the interest rate.

(The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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