How to qualify for competitive rates on low-interest personal loans

Low-interest personal loans are offered by banks, credit unions and online lenders to the most creditworthy borrowers. They come with competitive annual percentage rates (APRs) — usually below the national average of 12.10 percent as of March 13.

Unlike other personal loans, you’ll likely need to exceed the lender’s minimum requirements to qualify for rates this low. This could include having a FICO credit score above 800, making an annual income above a certain yearly threshold, having a clean credit record and having an established credit history.

How to qualify for low-interest personal loans

While every lender has different standards and minimum requirements, you could increase your chances of getting approved for a low-interest personal loan by following these seven steps.

1. Know your credit score

An excellent credit score gives you the best chance of receiving a low interest rate on a personal loan. Before applying, check your credit report to ensure your score is in the best shape and that no errors negatively affect your credit.

If there aren’t any mistakes on your report but your score could improve, try to keep any past-due accounts current and continue making timely payments on all your other accounts. Refraining from applying for new credit is equally important since each hard credit inquiry dings your credit score by a few points.

2. Pay down debt

When you apply for a loan — or any credit product — lenders will look at your debt-to-income (DTI) ratio to determine whether you can afford your potential monthly payment. To calculate your DTI, you can use a calculator to add up your monthly debts that appear on your credit report — including credit cards, loans and other regular debts — and divide that by your gross monthly income. Your DTI is the final number, expressed as a percentage.

In general, and especially with low interest loans, the higher your DTI, the higher your rates are likely to be and the lower your approval odds are.

Most lenders look for DTIs under 36 percent. However, yours will likely have to be lower to get the best rates. If your DTI is higher than 36 percent — or is getting close to it — consider some of the following methods to help you better manage your debt.

Ways to lower your DTI

• Follow debt repayment strategies: The debt snowball and debt avalanche methods are ideal for those with a steady income but unmanageable levels of monthly debt. Both require that you make the minimum payment on all of your debts, but the snowball method involves focusing on the smallest debts first, while the avalanche method requires you to pay down the debts with the highest rates first.
• Debt consolidation loans: Rather than looking at a low-interest personal loan, consider looking into a debt consolidation loan. When you consolidate, you take out a new loan (with a lower interest rate) that replaces your existing debt. This makes multiple debt streams easier to pay down and will save you money in interest over your loan term.
• Debt counseling: Credit counseling is a good option for those who don’t know where to start. Non-profit organizations, churches and banks offer credit counseling, sometimes for free. You’ll be paired with a credit counselor who will dive into your financial situation. From there, they’ll guide you through potential solutions and relief methods. Some counselors can even negotiate your debts with creditors for you.

3. Research all your options

Personal loans aren’t a one-size-fits-all type of product, and each lender has something different to offer. Before settling for the first one that looks good, prequalify for at least two loans. However, not every lender offers prequalification, so if you come across a loan that seems to meet your needs, research the details and rates to ensure it’s competitive for your credit profile. Also, review the customer service department hours and the customer reviews to ensure you’ll have the support you need throughout the application and repayment process.

If you aren’t sure where to start and are feeling overwhelmed, remember your options. You can check out online lenders, local and national banks or local and national credit unions. To further simplify the process, look into an online marketplace (like Bankrate). These marketplaces list the pros and cons, features and loan details to help you sift through all of your options to find the most competitive loans for your needs.

4. Look for discounts

If you already qualify for the lowest rate the lender offers, see if you could get any additional rate discounts.

The most common discount lenders offer is the autopay discount, which can help you knock off at least 0.25 percent to 0.50 percent of your rate. Some lenders also offer discounts for applying with a qualified co-borrower, for having another type of account with them or for having retirement assets.

Also, check with your bank or credit union to see if they offer competitive loans and what discounts they offer. Some offer rate reductions or benefits for existing customers. Plus, you may be offered other perks, like an extended grace period or the ability to change your monthly due date.

5. Only apply for the amount you need

It’s possible that you may get approved for a greater amount than what you were originally looking for. However, the lower your loan amount, the lower your interest rate will be. Likewise, by only borrowing what you need, you’ll be able to have a more manageable monthly bill than if you borrow a higher amount.

Crunch the numbers before you apply and comb through the lender’s terms and conditions page to look for any fees. While some lenders may waive specific fees or charge lower fees for those with excellent credit, be on the lookout for origination, prepayment and late fees. Also, don’t forget to calculate the interest rate into your monthly payment so you don’t come up short or take on a larger monthly payment than you can afford.

6. Consider credit unions

Credit unions are nonprofit organizations that exist to provide banking solutions to their members. Their personal loan rates are often lower than you’ll find with traditional banks.

You’ll need to apply for membership to work with a credit union. While some — like PenFed — may have easier qualification requirements, others may restrict membership to individuals who work for a specific employer, are affiliated with a particular organization or live in a specific area.

Some credit unions also extend membership to relatives of current members. Every credit union is different, so look into all of your local options before applying to ensure that you meet the minimum requirements.

7. Apply for prequalification

Most lenders allow borrowers to check their rates through prequalification before formally applying for a loan. For this step, you’ll need to provide your contact information as well as your estimated gross income, date of birth and Social Security number.

The best part about prequalifying for a loan is that you’ll know exactly what you may be eligible for with that specific lender without hurting your credit, as lenders only need to do a soft pull for this step. Prequalify for at least two lenders to get a well-rounded idea as to what you could qualify for.

How personal loan interest rates work

Lenders evaluate several factors to determine if you qualify for a low-interest personal loan, including your credit score, employment status and debt-to-income ratio.

Your credit score plays the most significant role because it lets lenders know how risky of a borrower you are based on how well you managed your loans and other financial products in the past.

FICO scores, which most lenders and creditors use to make lending decisions, range from 300 to 850. The most competitive rates are generally reserved for borrowers with excellent credit scores — between 720 and 850 — since the risk of defaulting on payments is lower.

You could still get approved with a lower credit score, but it may be more difficult. You can also expect a higher interest rate and more fees.

The average personal loan interest rate for borrowers with excellent credit is between 10.73 percent and 12.5 percent. But if your credit score is categorized as average — or 630 to 689 — the average rate is between 17.8 percent and 19.9 percent.

Personal loan eligibility requirements

Each lender has its own eligibility requirements for personal loans. However, there are some general guidelines that most lenders require to keep in mind before applying:

• Credit score. Do you meet the lender’s minimum credit score threshold? If your credit score is lower, you’ll likely pay more interest or be denied financing. If your score is above the minimum, you may be eligible for a more competitive rate.
• Income. Lenders want to ensure you have the means to make timely monthly loan payments. Some have a minimum income requirement that must be met to be considered for a personal loan, especially those that offer stellar or competitive rates.
• DTI ratio. Even if you have a steady source of income, a DTI that’s too high could signal to a lender that you already have too much debt on your plate. The lower your DTI, the more likely you will get approved for a low-interest personal loan.

What to look for when shopping for a low-interest personal loan

Once you understand how interest rates on personal loans work and what most lenders require, the next step is to shop around for the best deal.

• Interest and fees. Is the interest rate the lowest among your top selections? Are there origination fees, underwriting fees or early repayment fees? How does the APR (interest and fees) stack up to the competitors?
• Loan terms. Does the lender offer varying loan terms? If you can afford the monthly payment on a loan with a shorter term, the lender may offer you a lower interest rate. But an extended term is ideal if you need a lower monthly payment.
• Online prequalification. Can you get prequalified online without dinging your credit score? These tools make it easier to shop around and avoid formally applying with lenders that aren’t a good fit.
• Customer service. Does the lender have good customer reviews on websites like the Better Business Bureau or Trustpilot? Do they offer 24/7 customer support? Can you go to a physical branch, or do they only offer chat or phone assistance?
• Lender incentives. Are there referral bonuses? Can you receive a discounted rate for enrolling in automatic payments? Does the lender provide free access to your credit score or unemployment protection? These are all factors that can enhance the overall borrowing experience.

The bottom line

An excellent credit score, consistent income and low debt-to-income ratio are key to securing a low-interest personal loan. But if your finances aren’t in the best shape, consider taking a step back to improve your credit score and lower your utilization rate before applying.

If you can’t wait and need the funds as soon as possible, you can also try applying with a co-signer or signing up for an autopay discount to get a better deal. Most importantly, shop for the best low-interest personal loan for your credit situation, prequalify when possible and compare your options before taking out a loan.