When you’re struggling financially, sometimes the best option is to get a personal loan. Unfortunately, “cheap loans” in the form of low-interest rates are hard to come by if you don’t have the right credit score. The interest rate is the amount you’ll pay over the life of the loan on top of the loan amount requested. The higher the interest rate, the more expensive the personal loan will be, and the more you’ll come out of pocket to pay for it.
What is a low interest rate on a personal loan?
As of November 2020, the average interest rate on a 24-month personal loan is 9.65%, according to the Federal Reserve. Depending on your creditworthiness, your rate for a personal loan could be higher or lower than the national average.
Lenders use a risk-based model to determine individual interest rates on personal loans and other loan types. Financial institutions use several factors to determine your personal interest rate, including your:
- Credit score
- Payment history
- Income information
- Outstanding debts
The better your credit score and payment history and the less outstanding debts you have, the better your personal loan interest rates will be. However, if your credit score is lacking, you have trouble paying on time and maxed out your credit cards, don’t expect a low interest rate on your personal loan.
[ More: How to Raise Your Credit Score ]
How can I get a lower interest rate on my loan?
If you’re looking for a cheap personal loan with a low interest rate, there are some things you can do before applying. If you can improve your creditworthiness, you can get a better-than-average interest rate on a personal loan, which can add up to big savings over the life of the loan.
Lower your debt to income ratio
The first thing to do before applying for a personal loan is to lower your debt-to-income ratio, or DTI. The DTI is the amount of debt you have compared to the income you bring in.
The higher the ratio, the less likely you’ll get a low interest rate on a personal loan. With a high amount of debt compared to your income, the risk of default is higher, which means the lender will want a higher amount of interest to take on the greater risk.
The easiest way to lower your debt-to-income ratio is to pay off some of your outstanding debt. If you have a lot of debt or aren’t sure about the best way to tackle your existing debt, there are debt relief options available.
Improve your credit score
Your credit score is a three-digit number assigned to your debt and payment history that determines your creditworthiness. The better your credit score, the better chance you have of getting approved for a low-interest rate on your personal loan.
Here are some tips to use so you can quickly improve your credit score before applying for a loan:
- Pay all your bills on time
- Allow your utility and cell phone bills to boost your credit score
- Pay off your debt
- Keep low balances on revolving credit accounts
- Only apply for new credit accounts if needed
- Keep unused credit cards open and active instead of closing them
- Avoid applying for new credit often, as inquiries can negatively affect your credit score
- Review all your credit reports and dispute any inaccuracies
Shop around and compare rates
Sometimes it pays to shop around. By getting multiple personal loan quotes, you can compare interest rates, fees and other terms to make the best decision.
When shopping, make sure the lender does a soft credit check, which won’t affect your credit score. Once you choose a lender, it will do a hard credit pull to verify your information and lock in the interest rate.
Reach out to a credit union
A credit union is much different from a bank or online lender. Credit unions are nonprofit entities owned by their members, so they can offer more competitive rates and better incentives than the big banks.
To apply for a personal loan with a credit union, you have to be a member first. Qualifying for membership varies by credit union, but you usually have to live in a certain area, work for a particular employer or be related to an existing member. If you belong to an organization, that may also be a qualifying factor that makes you eligible to join the credit union.
Pick a cheaper type of loan
Most personal loans available are unsecured loans, which means you don’t have to provide collateral to get approved. However, offering up a form of collateral could be a way to get a lower interest rate on a secured loan compared to an unsecured personal loan.
Lenders may allow the following forms of collateral for a secured loan:
- Cash in checking or savings
- Home equity
Though this route could get a better interest rate, proceed with caution. If you default on the personal loan, the lender can seize your collateral. If you end up down on your luck, losing your house or car could make your situation even worse.
Get a co signer
Some lenders offer the option of a co-signer, which can get you a low-interest rate personal loan. The co-signer should have excellent credit and a strong payment history to improve your chances of a better rate.
Make sure your co-signer agrees to taking on the responsibility. Once approved, the co-signer is equally responsible for the loan payments. If you default on the loan, they are on the hook to pay or risk damaging their own credit score.
Choose a shorter repayment period
Longer loan terms means more risk for the lender, which translates to higher interest rates. Choosing a shorter repayment period can lower the interest rate, but it also increases the monthly payment. Be sure the higher payment fits into your budget over the life of the loan so you don’t default.
Sign up for an auto pay discount
Some lenders offer incentives like an autopay discount to win over borrowers. With autopay, you attach a checking or savings account to the loan and the lender debits the monthly payment automatically. Not only does this ensure you pay on time each month, it lowers the risk of defaulting on the loan, which is why lenders offer it.
Most lenders offer a 0.25% discount on the personal loan interest rate. It sounds small, but the savings can add up over the life of the loan. Be mindful to have enough money in your account each month to avoid overdraft fees on your account and a returned payment fee with the lender.
Fees on loans are the difference between an interest rate and an annual percentage rate (APR). If the APR is higher than the interest rate, there are fees attached to the loan.
One of the biggest fees is the origination fee, also called an administration, processing or underwriting fee.. The origination fee can vary from 1% to 8% of the loan amount. Not all lenders have this fee — lenders including SoFi, Lightstream and Citizens Bank all do not charge this fee.
When shopping for personal loan quotes, check to see what fees, if any, apply to the loan. Just because a lender offers a low-interest rate doesn’t mean it’s always the best option available.
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