A personal loan is a useful tool to help you get hold of money quickly if you need it. One might use the cash for practically anything, usually at times of emergency or to consolidate higher-interest debts.

But before you apply for personal loan, it’s a great idea to get acquainted with interest rates, one of the most important considerations that will help you decide which loan product would make the most sense for you.

Read on to get a better idea on personal loan interest rates and how they are structured.

How are Interest Rates Applied on Personal Loans?

Interests are charged as a fee to the lender for loaning out funds to a borrower and taking on risks. Loan products such as home, car and personal loans all charge different types of interest to account for their own specific set of challenges.

The system of interest rates for personal loans is similar to that of car loans, in that a fixed interest rate is applied to the principal sum borrowed. In other words, your interest costs remain the same throughout the tenure of your loan, no matter how much you’ve already paid.

The structure is unlike credit cards, which are fixed as well but calculated on a reducing balance, which means you are paying for interest only on the balance you owe (if any). It also differs from some home loans that apply variable interest rates on borrowings, which tend to fluctuate over the tenure of the loan.

The terms fixed and flat rates are sometimes used interchangeably but their exact meanings differ. In Malaysia, a flat rate can be understood as the amount to be paid back every month whereas the fixed rate is the interest rate applied over the loan’s term.

For example:

Assume you are paying a 7% fixed interest rate per annum, on principal borrowings of RM10,000 over a five-year loan term.

This means that your total interest costs would be RM3,500 (7% multiplied by loan amount and number of years in the loan term), where total repayment including interests, amount to RM13,500 over the five-year period.

Your monthly repayment would be a flat rate of RM225 (figures rounded up), where the principal is RM166.66 and the monthly fixed interest costs RM58.33.

The downside to fixed interest rates on principal borrowings is that you could end up paying more on interest because the sum remains fixed, even as you pay down your loan. However, the above calculations do not consider the effects of compounding interest owed every year or in other words, the effective interest rate (EIR).

Failing to consider this could lead you to perceive the interest expense as lower than they actually are in comparison to other loan products.

The EIR is how much interest you are really paying after considering the compounding effect of adding your owed interest to the total amount due. EIR is significant because it helps you compare between loan products.

For example, if you have an option to either pay with your credit card or take out a personal loan to make a certain purchase, you could use the EIR to pit the credit card’s per annum interest rate against the personal loan’s effective interest rate to accurately estimate which would help you save more.

What’s the Usual Fixed Rate?

The usual fixed rate for personal loans start from 6% per annum and may be higher. When you look for a personal loan with low interest it’s not easy to know exactly which rate will be offered because interest rates are dependent on a number of factors and vary between banks.

Your rate would first be determined by the loan amount. After that, the bank takes into account your credit history, annual earnings, loan term, credit history or credit rating and collateral (if any). It boils down to two basic considerations: the more you borrow and less risky you appear, the more favourable the interest rate you are offered.

Typically, a stable and middle to high income earner with a healthy credit history will enjoy a better rate overall.

Why Do Interest Rates Differ Between Loan Products?

Since each loan product carries different forms of risk and return possibilities, the interest rates applied will also show contrast. Personal loans are mostly unsecured and thus lenders take on a higher risk of providing funds with little option to recoup losses should borrowers default.

However, with car loans and home mortgages, the lender has the right to repossess the related asset and sell it off with the proceeds taken to offset the outstanding amount due.

Today, some banks require personal loans to be insured should the borrower be unable to make repayments due to death or disability. Credit card companies are also doing the same. The premium paid is usually borne by the borrower so it’s important to consider this cost as well when taking on an unsecured loan.

So, Are Personal Loans Worth The Interest?

With the convenience attached to personal loans such as immediate processing and fast release of funds for approved applications, you might ask, is it worth the interest rates that come with it?

For the most part, it gives consumers a safe option to obtain funds easily and quickly – when you need it. That said, there are other options that may be a better fit, like credit card balance transfer plans and easy payment plans.

Lastly, consider the necessity of the funds and its purpose and decide if the need outweighs the interest costs. In the end, it’s still a case of compare, compare, compare and we’re always on hand to help you out.

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• Interest Rates
• Loan Interest Rates