The two closest aspects that personal loans associate with are a) the interest rate and b) the credit score. The interest rate is what borrowers see, and the credit score is what lenders see. As such, both interest rates and credit scores are closely connected. Having a poor credit score can often lead to multiple rejections, bringing your credit score further down – it works like a cycle really, a bad credit score leads to rejection, rejection leads to applying with multiple lenders, applying with too many lenders triggers too many bureau inquires which is reflective of credit hungry behaviour, leading to further rejections as lenders estimate a higher risk quotient, and the credit score taking a mighty hit in the process.
When we make reference to interest rates on personal loans, it is important to note that the credit score and your repayment history significantly influence the cost of borrowing. As personal loans are unsecured loans that don’t involve collateral, the credit score becomes the single most dominant parameter that gives lenders information about your credit health and how good you’ve been at managing credit – going by which, a bad credit score means lenders know that they’re at risk if they lend you money.
Talking about how credit scores influence interest rates, the influence they have is massive, literally! Lenders employ the risk-based pricing model while giving out credit to individuals. The risk-based pricing model estimates the risk involved in lending money by calculating the probability that the consumer will default. Going by this, different borrowers will be borrowing at different costs – so different interest rates for different borrowers.
Going back to the question of whether it is possible to get a low-interest personal loan with a poor credit score, well, it’s not going to be possible. The interest is definitely going to be high, because lenders have to cover the risk in estimation of the probability that you will default. Defaults bring down credit scores heavily – even a single instance of default can pull down a credit score by a quantum of 80-110!
As such, with a poor credit score, getting a personal loan itself is going to be difficult, let alone getting a low-interest personal loan. If you find yourself in a situation like this, approaching a Fintech lender is your best bet. Private Banks are going to reject you, as most of them require higher than average scores for applicants to qualify for any form of unsecured credit.
Fintech lenders also adopt the risk-based pricing model while lending to customers. If a customer’s profile is indicative of high risk, the interest rate is clearly going to be high. While Fintechs are helping a larger section of working-class professionals to get access to instant and easy credit by offering personal finance to individuals with low income levels and low CIBIL scores, applicants often have to meet the lender’s internal credit norms in order to qualify. For instance, any lender, be it a bank or a Fintech company, expects applicants to have no instances of defaults in the last 6 months, and no EMI bounces over the last 3 months, regardless of their credit scores. Speaking of which, if you are an applicant with an average score of about 600 but have instances of defaults or EMI bounces in the last few months, you’re most probably heading toward rejection.
In accordance with risk-based pricing models adopted by lenders, individuals with good credit scores often find themselves getting lower interest rates on their loans than those with average or poor scores.The writer is Founder & CEO of Qbera.com