Interest on a personal loan is calculated based on the principal amount, interest rate, and loan tenure. Understanding how this interest is computed is crucial, as it directly affects the total cost of your loan. Whether you’re considering a fixed or reducing balance method, knowing how lenders determine your interest can help you make informed financial decisions and manage your loan repayments more effectively.
Need for Paying Interest to the Bank on Personal Loans:
When you avail a certain amount of money from the bank in terms of the loan, you need to repay the bank the total amount borrowed along with some interest. Interest is, in general, the charge you have to pay for utilizing the bank’s assets. Repayments are loans that take place in two manners. One in which you pay for the capital borrowed and in the other you pay for the incurred interest.
Factors that Govern the Rate of Interest:
There are certain factors, which have a direct role in the determination of the rate of interest. The key factors are mentioned below:
- Principal amount
- Terms of loan
- Schedule of repayment
- Amount of repayment
- Current Monthly income
- Credit history
The principal amount has a direct role in determining the rate of interest. Usually, banks don’t lend money as per the wish of the applicant but depending upon the amount the applicant can repay to the bank at the end of the loan tenure. The next thing on which the rate of interest depends is the Tenure of repayment. If you choose to repay the loans in a shorter period, then the repayment amount would be higher and vice versa. If the repayment schedule increases, then the rate of interest decreases. This is for the effect of compound interest. If you have an impressive credit history, then banks can offer you loans at a reduced interest rate.
Calculation of Interest on Personal Loans
The interest on a personal loan is calculated using a basic formula.
E = P x R x (1+R) ^n/ ((1+R) ^n – 1)
Where P = Principal
N = Tenure of the repayment
E = Equated monthly instalment
R = Rate of interest
The process of carrying out manual calculation can be time-consuming. If you want to know more about the interest and EMI before availing a personal loan, then it highly recommended making use of a personal loan calculator. You can also check online personal loan eligibility to know more about your eligibility for a personal loan.
Before you apply for a personal loan, it is highly recommended to go through all the terms and conditions of the bank and its type of personal loan you are availing.
Read Also: Personal Loans: The Pros and Cons
