7 Things You Need To Know About Personal Loan Interest Rates

Personal loans can be a smart alternative to credit cards, often offering lower interest rates and a chance to build or strengthen your credit. Your own bank or credit union may have competitive options, but shopping around is key to getting the best rate.

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Before you borrow, it helps to understand the biggest factors that determine what rate you’ll pay. Here are seven key things you need to know about personal loans.

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These Factors Determine Personal Loan Interest Rates

Interest rates on personal loans are determined by larger economic forces and the individual borrower’s credit history and score. Some of the factors that have the biggest impact are:

• Economic environment: Federal Reserve policy, inflation and overall credit market conditions drive rates up and down.

• Lender’s risk tolerance: Rates also reflect the lender’s own costs, operational overhead and their risk tolerance for potential loss if a borrower defaults.

• Borrower-specific factors: Lenders evaluate individual borrowers’ credit scores, debt-to-income (DTI) ratio employment status and repayment history.

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Credit Score Has a Big Impact on Your Rate

Of all these factors, credit score plays a big role in the rate you’ll be offered, as it’s the lender’s way of understanding their level of risk in loaning you money.

Higher credit scores (670 and up) may qualify for lower rates, while those with scores in the fair (580 to 669) to poor (below 580) credit tiers may see significantly higher interest rates.

Loan Length Affects Interest Rates

The loan length determines how quickly or slowly you’ll repay the money you’ve borrowed and will also affect how much interest you pay. Shorter-term loans (24 to 36 months) tend to come with lower rates as a kind of incentive for the likely lower risk the lender is taking. Thus, longer-term loans (60 to 84 months) tend to come with higher interest, since there’s a greater likelihood of missed or defaulted payments the longer you have to pay it back.

While a longer-term loan often results in a lower monthly payment, over the life of that loan you’re paying a lot more in interest.

For example: A $10,000 loan at 10% over three years costs around $1,600 in interest. The same loan at 12% over seven years will cost you around $4,800, additionally — a significant amount of money.

Fixed vs. Variable Rates

There are two main ways that interest can be applied to your loan, either fixed-rate or variable-rate loans.

• Fixed-rate loans: Your interest rate stays the same over the life of the loan, which keeps things simple and predictable.

• Variable-rate loans: These loans are tied to benchmarks like “the prime rate.” They may start out lower than fixed loans but can rise if interest rates increase, which is risky and makes it harder to predict payments and interest accrued.

Fixed-rate loans are the safest for the average borrower because there are no surprises, and you can even get ahead and make additional or bigger payments.

Fees and Hidden Costs

Even if the interest rate on a loan looks great, always take a closer look and read the fine print. Fees can drive up the rate you’re actually paying, such as:

• Origination fees: Often 1% to 8% of the loan amount

• Late fees: Flat fees or a percentage of payment amount

• Prepayment penalties: Some lenders still charge for early payoff of loans, though it is not as common.

How To Shop for the Best Rates Without Hurting Credit

Borrowers have to be careful when shopping for a loan so that it doesn’t show up on your credit report. Some tricks to do this include:

• Use prequalification tools: Soft credit pulls are a way to rate-shop without affecting your credit score.

• Compare lenders: Online tools exist to help you compare rates at banks, credit unions and fintech lenders. Credit unions often offer lower-than-average rates.

• Consider co-signers or co-borrowers: If there’s someone with excellent credit who is willing to partner with you to obtain a loan, this can often reduce your rate.

Read the Fine Print

If a loan and rate seem a little too good to be true upfront, and even if they seem right on target, always look into the fine print for details that can add costs or change your payments. Some things to doublecheck include:

• APR vs. interest rate: Your annual percentage rate (APR) includes interest and some fees, but not always all costs. Always compare APRs not just the headline rate.

• Penalty clauses: Late fees, prepayment restrictions or variable rate adjustments can balloon the cost of a loan.

• Total repayment cost: Calculate how much you’ll pay in full — not just the monthly payment

The “best” personal loan isn’t just the lowest advertised rate, it’s the one with the lowest total overall cost, the best repayment terms and the one that fits your financial plan. By comparing offers carefully and reading the fine print, you can borrow wisely and avoid paying more than you need to.

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This article originally appeared on GOBankingRates.com: 7 Things You Need To Know About Personal Loan Interest Rates