Module Units

## Interest Rate

Now let us come to the most important aspect of personal loans – the interest.

### What are the typical interest rates of personal loans?

Honestly speaking, there is no hard and fast rule about the interest rate of personal loans. Since it is an unsecured loan, lenders are free to decide their own interest rates. The interest rate depends on a variety of factors such as the borrower’s credit history, salary, the amount borrowed, employer, city of residence, and others.

If a borrower has a good credit rating or has a good history of paying their loans on time or is employed with an established organization, the risk is considered to be low and the interest rate offered is also lower.

Below are some of the personal loan interest rates charged by banks and NBFCs as of 17th November 2021:

*Please note that the actual interest rate and the lending amount varies on a case to case basis. Also, interest rates are subject to change by Banks/NBFCs.

### How is interest calculated on a personal loan?

Interest on most personal loans is calculated based on the system of reducing balance. Let us understand what it means.

Each EMI that a borrower pays on a personal loan consists of two components – principal amount + interest amount.

So, with each EMI, the borrower pays back a part of the principal along with the interest. In the reducing balance system, the interest is calculated on the remaining principal only.

Let’s understand this through an example.

Suppose a borrower borrows ₹ 100,000 for 24 months at the interest rate of 12% per annum. His monthly EMI will be ₹ 4.707. The EMI breakup for the first month will be like this

So, in month 2, the interest will be calculated on the outstanding principal amount of ₹ 96293 and not the total of ₹ 100,000. Thus the first 12-month principal + interest breakup will look something like this:

Other charges:

Apart from the interest rate, there can be other charges associated with a personal loan such as processing fees, EMI bounce charges, penal interest etc. Please learn about these carefully at the time of taking the loan to avoid any surprises later on.

Some of the most common charges incurred while availing a personal loan are:

• Loan processing charges: Since the lender has to bear some administrative expenses while processing and sanctioning a loan, they charge a processing fee from the borrower, which varies from one lender to another. But in general, it ranges between 0.5% to 2.5% of the total loan amount.
• Verification charges: Sometimes, banks hire an external agency to conduct a verification of the borrower to assess whether he/she can repay the loan. The charge for this is taken from the borrower in the form of a verification charge.
• EMI default penalty: In case a borrower defaults on an EMI, a charge is levied on the loan as the EMI default charge. It is strongly advised not to default any EMI, not just to avoid this charge, but to add a bad record to the credit history.
• Duplicate statement fees: The bank/NBFC regularly sends statements to borrowers. However, in case the borrower asks for a duplicate statement from a bank, the bank charges a fee for statement generation.
• GST Tax: Any additional service required during the tenure of the loan will attract a GST tax, which has to be borne by the borrower.
• Prepayment/Foreclosure fee: In case the borrower wants to pay off the loan, ahead of the tenure, the bank may charge a fee for foreclosure. This amount usually varies between 2-4% of the loan amount. We have discussed this in detail in the next section of this module.

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