Perhaps you need start-up finance for your small business, or you’re thinking about renovating your home. Taking out a personal loan may seem like the right fit, but do you know how much interest you’ll pay?
Justmoney takes a look at what influences the interest rate on a personal loan, the difference between secured and unsecured loans, and its impact on the interest rate.
Tip: Fill in this form to find out whether you qualify for a personal loan.
Interest rates on personal loans
According to Dawid Möller, who used to work in Old Mutual’s marketing department, the interest rate on a personal loan is determined by your personal credit score or bureau score.
“This comes down to the history that the credit institutions in South Africa have of you. They look at your past behaviour to estimate what the risks are for lending you money today,” says Möller.
He adds that the lower the risk, the lower the interest rate and vice versa. In other words, if you have a bad history with credit, financial institutions will charge you a higher interest rate, and if you have a good history with credit, they will charge you a lower interest rate.
READ MORE: Penalties for paying off your personal loan early
Secured vs. Unsecured
Loans are either classified as secured or unsecured. The former refers to loans that are tied to an asset, such as home loans or vehicle loans The latter refers to loans that are not tied to an asset, such as personal loans.
Secured loans are considered a lower risk to financial institutions because they can claim back any losses from the attached asset. For example, if you default on your monthly payments on your home loan, they can cease your home and sell it to make back the money you still owe them.
However, since unsecured loans are not attached to an asset, financial institutions may not be able to recover any loss if you can’t make payment. As a result of this risk, unsecured loans usually have higher interest rates than secured loans.
Möller says this is because there is no surety or security.
“The term for an unsecured loan is often shorter than for a secured loan. You are also often required to take out credit life insurance. This protects the lending institution if you pass away before the loan is settled,” says Möller.
Reasons to take out a personal loan
According to Herman Lombard, founder and executive director at African Unity, consumers should only take out a personal loan if it will allow them to turn the loan amount into something more.
For example, taking out a personal loan for home improvements, to study further, or running a small business from home.
“Home renovations add value to your property, so it’s a good investment. A student loan allows you to get an education and increase your long-term earning potential, and a small business loan can help you set up or expand your business,” says Lombard.
He offers the following advice to readers who are considering taking out a personal loan:
- Be aware of how much is owed and to whom.
- Pay accounts on time and never skip payments.
- Draw up a monthly calendar for payments.
- Commit to paying the minimum required amount.
- Identify which debt is the most urgent to settle – consider the one with the highest interest.
- Set up a budget for each month in a bid to control your spending.
“Be conscious of the type and purpose of the debt you take on. Remember to protect your future self. The right amount of good debt can help you save for the future, without any bad debt,” says Lombard.
If you want to take out a personal loan for the right reasons, find out whether you qualify.