The process of taking out a personal loan can be overwhelming for many people. From worrying about whether your loan application will be approved to combing through the fine print and understanding loan terminology, the experience can be a daunting one.
Personal loans can be attached to some exciting and joyous periods in our lives (when we are seeking a loan for a wedding or a car loan for a new ride), or they can be linked to incredibly difficult times (when we need a cash advance to help with sudden and unexpected medical expenses, for example).
Whatever the reason that prompts you to apply for a loan, a basic understanding of how personal loans work can ease your mind in the process and help prepare you to choose the best possible loan for your circumstances.
That choice could be dictated by the loan with the best APR, which leads us to the question: “What is a good APR on a personal loan?” In order to answer that, we will start with a basic understanding of how APR works.
APR: What Is It and How Does it Work?
APR stands for “annual percentage rate,” referring to the interest rate and fees charged in conjunction with a loan, whether it is a cash loan or a loan of goods or assets (like an automobile). Most consumer loans use an APR rate, which does not compound interest.
Lenders are required to disclose APR to borrowers. This was a significant 20th-century initiative with the Truth in Lending Act in 1968, which was created to protect consumers.
Today’s loans are much more transparent than in the past; however, this does not mean some consumers are still unclear on how APR works or sign on to loans without researching all of the possibilities for securing a good interest rate.
APR can be calculated with these steps:
- Add the total interest paid over the life of the loan with any loan fees
- Divide that number by the amount of the loan
- Then divide that number by the term of the loan expressed in the number of days
- Multiply that number by 365 to generate an annual rate
- Finally, multiply that number by 100 to turn it into a percentage
What is the Average APR on Personal Loans?
The major credit bureaus report 9.41% as the average interest rate on an APR loan rate on personal loans, with your credit score being the main driver in terms of how the lender calculates your percentage.
Consumers with a solid credit history can expect an APR of 15% or less, but those with a poor or nonexistent credit history could be faced with an APR as high as 60% or more.
Basically, the higher the risk you are as a borrower, the higher your APR will be on a personal loan. To ensure you are getting good credit card apr, be sure to keep the average credit card apr in mind and compare rates among lenders.
Factors That Affect Your APR
There are many factors that lenders place a heavy focus on when determining your APR. Your credit history, for example, is of great importance.
All lenders will look at your credit report to determine if you have good credit or bad credit. You may want to look into this yourself before looking to secure a loan, in case you need to take steps to improve your score.
There are also several other important factors you should be aware of before submitting a loan application.
Before a lender will agree to offer you a loan or establish the APR, they will want to review your income. In addition to assessing you by your credit score, the lender will consider whether your income will enable you to pay back the loan. You will need to provide proof of income with pay stubs or other documentation required by the lender.
Debt to Income Ratio
Even if your income is relatively high, it may be offset negatively in the lender’s assessment by a high amount of debt. Your debt-to-income ratio (DTI) is another way to predict your ability to repay a loan.
This figure is calculated by taking all of the debt payments you make each month (such as your mortgage loan, credit card debt, student loan, and auto loan payments) and then dividing the total of those bills by your gross monthly income.
A higher DTI will be a red flag for a lender—indicating you are already close to maxed out on debt and it is likely you would struggle to make the payments every billing cycle. A lower DTI is a promising sign for a lender, and in turn, it would help you secure a lower interest rate.
If your credit and income history do not make you the best candidate for a personal loan, you may be able to improve your odds by adding a cosigner.
This may be a family member with better credit who is willing to sign on to the loan with you, and their willingness to assume responsibility for the debt could result in a lender lowering APR.
How To Compare Personal Loans: Good APR and More
Before you sign on the dotted line, you should be sure you have compared loan options to find the one that works best for you.
The best APR you can get is indeed a priority, but there are also other factors you should compare. Use this checklist when assessing the personal loans before making your final decision:
APR: If your credit history is good, then a good APR will be under 20%, and excellent credit will be under 10%.
Loan Term: Go for the shortest term you can afford, which will lower your APR.
Monthly Payments: Be sure the monthly payment is an amount you can afford while keeping up with all of your other financial obligations.
Fees: This is where the fine print is incredibly important. Be sure you understand every fee that is attached to the loan, including things like penalties for an early payoff, any interest charge, or an annual fee. Ask the lender to review every fee in detail before you agree.
Discounts: Wherever possible, try to take advantage of discounts that could be available from lenders. For example, you might be eligible for better rates by using a bank or credit union where you already have a checking or savings account.