(posted on WalletHub, June 2021)
What advice do you have for someone who wants to lower their personal loan rates?
Suppose that you are offered a ten-year personal loan at 5% per year, and you want to lower your rate. There are several things one can do. First, shop around since rates vary between lenders. Oftentimes, if you have a relationship deposit account with a bank, you can benefit from a slight decrease in the loan rate, usually a quarter to half a percent. You could choose to borrow for a shorter term (say five years instead of ten), and while your interest rate will be lower, the monthly payments will be larger so make sure that you can afford to make the payments. You could also explore other ways of borrowing. You could take a home equity loan, for example, where interest rates could be lower since they are secured by your home equity. Or you could put off the expense by a year or two while you work to improve your credit score, which can give you a lower rate when you borrow in the future. Who knows, after two years you may decide you no longer need to borrow the money, which may be the best outcome!
Why do you think personal loan interest rates are lower than credit card interest rates?
Usually, with a personal loan, monthly, fully-amortizing, payments are needed. Since you are paying off a part of the principal amount of the loan each month, the loan balance declines with every monthly payment, and the risk exposure of the lender continually decreases. With a credit card, one only needs to pay the minimum amount (usually $35 or so) and you can carry the rest of the balance all the way up to your credit limit. This increases the risk for the lender since the loan amount is not steadily decreasing. Hence, credit card rates tend to be higher than personal loan rates. Second, personal loans are based on your personal credit history, so they are more customized. However, credit cards are typically marketed to a group of customers, and the interest rate will be set based on the typical customer in that group. If your credit score is better than that of the average credit card customer, your personal loan rate will likely be lower than what you can get with a credit card. Further, the less well-off folks (with lower credit scores) will be more likely to carry a monthly credit card balance, whereas the more well-off folks will be better able to pay off the balances in full and not carry a balance. Hence, the credit card loan portfolio is likely to be titled towards folks with poorer credit scores (this is called the adverse selection problem in finance), and the loan rates will be higher to reflect this higher risk.
How important do you think personal loan APRs are compared to other personal loan terms?
The APR is important, but it is equally important to consider the loan term. Too short a loan term means the monthly payments will be larger, whereas too long a term may mean one is unnecessarily paying interest (which may be higher than what you can earn on your investments, so it is a net negative). It would also be important to check other factors such as whether there are penalties for prepayments (if your financial condition improves), possibilities for extensions should your financial condition deteriorate, any additional fees that would be charged, discounts if you set up automatic bank withdrawals or if you belong to some groups (veterans, AARP, your employer (check with your HR), etc.), availability of customer service support during weekdays and/or weekends, availability of discounts if you open a checking or direct deposit account, etc.