Personal loan companies often offer a wide APR range. The rate can vary from 2 percent to over 30 percent, which can be confusing for potential borrowers. What determines the APR? Why is it important? How do I know if I will pay 2 percent, 5 percent or even 30 percent? There are many key factors that influence the APR of your personal loan and determine if your loan falls on the lower or higher end of the advertised range.
What is an APR?
An Annual Percentage Rate (APR), is the yearly amount borrowers will pay on a loan, expressed as a percentage. It differs from interest rates because it accounts for additional fees and charges (except compounding); therefore, it is usually a higher percentage than your normal interest rate. APRs are particularly helpful in comparing loans. While many factors determine if a loan is right for your needs, generally you want to look for a lower APR.
What factors influence APR?
A number of factors influence a loan’s APR. Five of the most influential factors include your credit score and history, debt-to-income ratio, annual income, job history, and the terms of the loan.
1. Credit Score and History
Your credit score and history is often the most influential factor on your APR. According to the Federal Trade Commission, a variety of factors work together to form your credit score:
Years of credit history
Number and type of open credit lines
Number of on-time payments
Amount of available credit
Typically, the higher your credit score, the lower your loan’s interest rate. Some personal loan companies have a minimum requirement for credit scores; Prosper requires a minimum credit score of 640.
2. Debt-to-Income Ratio
Your debt-to-income (DTI) ratio is another major factor when qualifying for personal loans. Your ratio is determined by your monthly debt (such as mortgage, car loans, etc.) divided by your gross monthly income. This number is typically represented as a percentage. A lower percentage indicates less debt relative to your income. Lenders prefer to see a lower DTI number.
3. Annual Income
Annual income affects your debt-to-income ratio and is often taken into consideration when you are offered an APR. Higher incomes typically lead to lower rates. Some lenders may require a minimum annual income; Discover requires a minimum household income of $25,000.
4. Employment History
Lenders want to know that their loans will be paid in full. They may look at your employment status and history to determine if you are a high risk: for example, if you change jobs frequently. Customers who are self-employed may also have to submit additional information to verify their employment status and financial stability.
5. Loan Terms
Sometimes the length of the loan may impact its APR. A shorter loan length generally has a lower APR. In addition, the type of rate, fixed or variable, will greatly impact your annual percentage rate. A fixed rate will remain the same for the life of your loan. A variable rate will change, and usually increase, throughout the life of the loan.
There are many critical factors that impact your APR. This number is extremely important when comparing personal loans. Look at our top ranked personal loan companies to help you compare APRs and find the one that best meets your needs.