Potential effects of rising interest rates on personal loans
Interest rates are a critical factor in personal loans and can significantly impact borrowers’ monthly payments. The interest rate on loans is determined by several factors, including the borrower’s credit score, income, and debt-to-income ratio. However, one factor that can significantly impact the interest rate and, in turn, the borrower’s monthly payment is the prevailing interest rates in the market.
Let’s examine some of the potential effects of rising interest rates on personal loans.
- Higher interest rates
The most apparent effect of rising interest rates is that personal loan borrowers will have to pay higher interest rates. Personal loans interest rates in India are influenced by the Reserve Bank of India’s (RBI) monetary policy decisions, specifically the repo rate. When the RBI raises the repo rate, banks’ cost of borrowing from the RBI increases, and this cost is passed on to borrowers in the form of higher interest rates.
For example, if A takes a personal loan of Rs. 5 lakhs at an interest rate of 10% per annum for a tenure of 5 years, then the monthly EMI will be Rs. 10,582. If the interest rate increases to 11%, the EMI will increase to Rs. 10,930. This means that A will end up paying more interest over the loan tenure, resulting in higher overall costs.
- Higher processing fees
Rising interest rates can also result in higher processing fees. Banks charge processing fees to cover the administrative costs of processing a loan application. When interest rates rise, banks may increase processing fees to compensate for the higher cost of borrowing. This means borrowers will have to pay more upfront costs to obtain a loan.
- Reduced access to credit
Another potential effect of rising interest rates is reduced access to credit. When interest rates are high, banks may become more selective in lending, resulting in a higher rejection rate for loan applications. This can make it challenging for borrowers with a lower credit score or not meeting the bank’s eligibility criteria to obtain a personal loan.
- Extended loan tenure
Rising interest rates can also result in extended loan tenure. When monthly payments increase, borrowers may need help to keep up with their payments and may seek to extend the loan term to reduce their monthly payments. Extending the loan tenure may lower the monthly payment. Still, it also means that the borrower will end up paying more in interest over the life of the loan.
- Impact on credit scores
If borrowers are unable to make their monthly payments on personal loans due to higher interest rates, this could negatively impact their credit scores. This may make it more difficult for them to obtain loans in the future.
Rising interest rates can significantly impact personal loan borrowers in India. It is advisable to look around and compare loan offers from different lenders to find the best deal. Borrowers should also maintain a good credit score and avoid taking on too much debt to improve their chances of obtaining a loan with favorable terms.