A personal loan is an unsecured loan which can be taken without collateral. With proper documents and a good credit score, it is quite easy to apply for one. Repayment of a personal loan, like any other loan is made in two parts – the principal and the interest.

The interest is charged on the loan amount which is a separate component and is over and above the principal loan amount. Let’s look at how the interest rate is calculated on a personal loan.

## What is an interest rate?

An interest rate is a percentage charged by the lender as an annual percentage of the loan outstanding. Interest is paid on a monthly basis by the borrower. It is calculated based on the credit history, credit score, loan amount and monthly income of the borrower. For a personal loan, the interest rate can fall anywhere between 10-20% normally.

## How is interest calculated?

The basic formula that is the basis for an interest calculation is –
Interest = Principal x Interest Rate

Let’s look at an example!

Roshan takes a personal loan of INR 2 lakhs at an interest rate of 15% per annum to be paid back in 60 months or 5 years.

Monthly Interest = 200000 x 0.15/12 = INR 2500
Principal to be paid each month = INR 8333.33
Total EMI = Principal + Interest

In this case, Roshan will have to pay the first month’s EMI of INR 10833.33

Now, for the second month, the interest will be calculated on the new balance which is (200000-8333.33) 191666.67.

Similarly, each month the interest is calculated on the new outstanding balance which is calculated by subtracting the monthly principal from the total loan amount.

## How is total interest calculated?

By adding up the interest paid over the entire year, you can arrive at the total interest for 12 months. By determining the interest amount each month, you can create your own monthly EMI calculator to keep track of your repayment.

Interest rates on a personal loan are usually higher when compared to a housing loan or an education loan as it does not involve any collateral. Since there are no collaterals required, the documentation is also very minimal in nature.

In this digital age, with the advent of paperless loans, the requirement of going through an elaborate application process has been eliminated and replaced with a quick form submission online followed by uploading scanned copies of your documents. It usually takes 1-7 days for your loan to get approved depending on your profile. In some cases, the time period may be longer. In all, personal loans are a very easy, convenient and hassle-free option for immediate funding.

DISCLAIMER

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.

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