The Basics of Interest on Loans

You’ve heard the term thrown around before and it’s something you might even be familiar with. But how much do you know about interest and the aspects that it covers when it comes to instant personal loans? Understanding the jargon around finance can help you make better financial decisions overall and improve your financial wellness.

So, let’s break down Interest and its different elements so you can boost your financial know-how.

What is Interest?

To put it simply, Interest is the cost of borrowing money. Imagine you lend your friend ₹500 and you ask that they repay this amount in 2 months. They can repay this amount in installments. However, you’ve asked your friend to pay an additional ₹25 on each instalment when they repay the amount. This additional sum is what is commonly called the monthly rate of interest.

Before you apply for an instant personal loan, let’s cover the definitions of various interest-related terms so that you can understand the process more easily.

Interest Terms You Should Know

Principal - To remember this more easily, the word ‘Principal’ itself is a big hint as another meaning for the word is ‘first’. The principal amount is the initial amount you borrow from the lender without the additional interest charged on it.

Interest Rate - An interest rate is an amount a lender charges a borrower for the use of certain funds or assets. Interest rates are generally a percentage of the principal and are based on the principal amount you’ve borrowed. This additional amount or ‘interest’ that is charged by the lender is to cover their loss of money during the period that the borrower has utilized it. The lender could have used this amount for some other means, but instead, they have lent it to the borrower and so a cost of debt is incurred.

Capitalization - Capitalization is when a borrower skips the repayment of interest. The unpaid interest is added to the principal amount so that it can be repaid by the borrower. If repayment is postponed, the interest accrues on the principal amount until it’s repaid.

How do I get a low-interest rate?

This is where your credit history comes into play. When a friend asks to borrow money from you, you’re likely to think about the other times you’ve lent them money. Have they repaid you on time? Were the repayments postponed too often? All of these questions play an important role in determining whether you will lend them the money they’ve requested.

Before they approve your loan, lenders check your CIBIL score i.e your credit report. This will give them an idea about your repayment history and whether you’re a worthy candidate for an instant personal loan. If they find a history of postponed payments, the lender can either reject your application or charge a higher rate of interest. Borrowers that are considered low risk are charged lower interest rates than those who are considered high risk. This is why it’s best to manage your finances well so that when you apply for an instant loan, you can be sure to get a low-interest rate or a higher credit limit.

How do I choose a lender with an Interest rate that suits me?

Before you apply for an instant loan, make sure you identify the right lender so that you don’t fall into a debt trap or end up with a fraudulent platform that scams you out of your hard-earned money. You can approach lenders such as banks, NBFCs, or trusted FinTech companies. As each institution has a different eligibility requirement as well as loan amounts and interest rates, it’s vital you compare the pros and cons of each one so you can make an informed decision. Check the suitability of your chosen lender according to the amount of the loan, the interest rate being offered, documentation requirements, the length of the disbursal process and eligibility conditions.

To Wrap Up

While the concepts behind financial terms are relatively simple to understand, the terms themselves can be confusing for those that are learning to manage their finances for the first time. The one rule that you should keep in mind is ‘Knowledge is power’ and by growing your vocabulary, these concepts will become easier to navigate.

When it comes to applying for an instant loan, don’t be put off by words such as ‘high-interest rates’. Instead, think of applying for a loan like shopping for a phone. If you were buying a phone, you’d definitely want to select a phone from a trusted brand, which is affordable and also meets your needs. The same goes for selecting your loan; weigh the pros and cons of your lender, interest rates etc. before making your decision. If you apply for a loan with this mindset, you’re sure to find interest rates that suit you so your credit score stays healthy.