Risk-based pricing is commonplace overseas and has grown in popularity in Australia in recent years with the introduction of comprehensive credit reporting (CCR).
So how do risk-based personal loans work? Find out here, as well as how to compare them and how lenders determine your rate.
In the market for a personal loan? The table below features personal loans with some of the lowest interest rates on the market.
What are risk-based personal loans?
Risk-based personal loans don’t have a set interest rate but rather a maximum and minimum interest rate. When applying for a loan, a lender will offer you an interest rate within this range, based on a number of factors. Typically, these factors will determine how risky of a borrower you are to the lender.
The introduction of CCR means good credit behaviour is taken into account when calculating credit scores, as previously only negative behaviour was recorded. Lower-risk borrowers will be offered a lower interest rate, and higher-risk borrowers will be offered a higher interest rate. If you have a poor credit history or large amounts of debt, you’re likely be considered high-risk.
A risk-based personal loan may reward borrowers who have demonstrated good credit behaviour with a lower interest rate than a regular personal loan’s one-size-fits-all settled interest rate. However, this isn’t always the case - some regular personal loans can have lower interest rates than even the lowest rate on a risk-based loan’s range.
Lenders will often give you an estimate of what your interest rate would be under their risk-based pricing before you submit a full application. This shouldn’t affect your credit score.
How is your risk-based interest rate calculated?
Each lender will have different criteria and algorithms to determine what interest rate is offered to each borrower. Lenders won’t reveal the algorithm behind their calculations but typically the following factors are taken into account when deciding to lend to someone:
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Loan amount: The lender needs to know how much you’re borrowing in order to gauge the level of risk and figure out whether lending the funds to you is worth it.
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Loan length: The loan length will help determine how high the repayments will be, with shorter terms having higher repayments. The lender may use this to consider how well you can afford the repayments as well as how much interest it can earn from you. It’s typically advised to opt for the shortest loan term you can afford because shorter loan terms mean you’ll pay less in interest costs, potentially saving you thousands.
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Credit score: Your credit score is one of the most important metrics a lender will judge you by. It’s a numerical representation of all your credit behaviour, both positive and negative, demonstrating your ability to repay debt. Borrowers with great credit scores generally attract lower interest rates, while borrowers with high credit scores often attract higher rates.
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Existing debts: Lenders will likely ask you to disclose any existing debts you have. Borrowers with large amounts of existing debts will likely be offered a higher interest rate, or in extreme cases, may be denied for a loan.
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Employment: Your employment status may greatly influence the interest rate offered. How long you’ve been in the role could also be factored in, as well as whether you’re full-time, part-time, or casual. It can be very difficult to get a loan if you’re unemployed.
How to compare risk-based personal loans
If you’re in the market for a personal loan and you think risk-based pricing may suit you, these are the things to consider when shopping around:
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Interest rate range: Just because you’re not getting an exact interest rate, doesn’t mean you shouldn't look for the best deal possible. Some lenders may have low minimum rates but very high maximum rates, leaving you open to a nasty surprise after applying. Make sure you get quotes from a number of lenders to ensure you’re getting the lowest rate possible. These quotes shouldn’t affect your credit score, so you can get as many as you need without fear of your score dropping.
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Loan amount: Some lenders will have a high minimum loan amount and others a low maximum amount. Make sure the loan amounts suit your needs and you don’t stretch yourself to accommodate the lender.
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Fees: Risk-based pricing means you may be able to get a lower interest rate, but this system doesn’t apply to fees. Make sure you aren’t getting stung with numerous upfront and ongoing fees and check the comparison rate for an idea of how high the fees are.
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Extra repayments: If you want to pay off your personal loan sooner and save on interest costs, you may want the option to make extra repayments. Some lenders won’t allow this, will charge for it, or will have a maximum amount you make in extra repayments.
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Security: Some lenders may only offer secured personal loans, which means you’ll have to provide security for the loan. This often comes in the form of an asset, like a vehicle, or a term deposit, and is a type of insurance for the lender.
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Risk-based calculations: Prior to application, you should be able to ask the lender to disclose the factors that are taken into account when your interest rate is calculated. Some lenders will have a large number of factors, which may or may not work in your favour. See what they’re evaluating and see how it will apply to your circumstances.
Who can get a risk-based personal loan?
Like other loans, risk-based personal loans usually have the typical eligibility criteria you’d expect: aged 18+, employed, Australian citizen or permanent resident etc.
For those with a bad credit score, risk-based personal loans can still be a valid option. Because of the flexible interest rate, risk-based loans may be easier to qualify for than regular personal loans. While you may incur a higher interest rate with a risk-based personal loan, regular loans with a set interest rate could have more stringent criteria which may prevent you from being approved for a loan.
You should still try to improve your credit score though, which you can do by reducing debts, paying your bills on time and cancelling credit cards.
How to apply for a risk-based personal loan
Lenders will have slightly different application processes, but the format is likely to look like the following:
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Interest rate quotes: Find a number of lenders with a suitable interest rate range that may suit your circumstances. You can submit a rate estimate to each of these to ascertain what your rate may be from each. This is much shorter than a full application and doesn’t affect your credit score.
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Submit application: After reviewing your interest rate quotes, decide on which lender you want to go with based on the lowest rate and which suits your needs best. Submit an application with all your personal details, loan amount, and loan length. Keep in mind the rate they gave you was just an estimate and may not be the final rate offered to you. This application will affect your credit score.
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Wait for approval: The lender will review your application, which could take anywhere from a day to weeks.
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Sign off: Once approved, you can review the final rate the lender has offered to you, as well as whether you’ve been approved for the full loan amount and any other terms. If you’re happy, sign on the dotted line and accept the loan.
Savings.com.au’s two cents
If you have a good credit score, risk-based personal loans could afford you a lower interest rate, but not always. The offered rate may still be higher than the rates offered by regular personal loans.
Meanwhile, If you’ve got a bad credit score, you may have a better chance of being approved for a risk-based personal loan than a regular personal loan, although the interest rate is likely to be higher than average.
Ensure you shop around and get quotes from a variety of lenders to help you land the lowest personal loan interest rate for your situation.
Photo by Kriti Tara on Unsplash
Harrison Astbury
Harry O'Sullivan
