Why does my personal loan interest vary month to month?

Why does my personal loan interest vary month to month?

If you aren’t quite sure how interest is calculated on your personal loan, it may come as a surprise learning that monthly interest charges vary even on fixed rate loans. 

Each month when you make your personal loan repayment, you may notice that the proportion of the repayment that goes towards interest charges typically changes from one month to the next.

This can be particularly confusing if you have a fixed rate personal loan, as you might have expected that a fixed interest rate means fixed interest payments. But, there’s a fairly simple explanation as to why this is the case.

It comes down to two main factors:

1. Interest is calculated daily and typically charged monthly.

Since the number of days in a month can change from one to the next, interest charges may be slightly higher in the longer months and lower in the shorter months. 

2. Interest is charged on the principal balance. 

The reason you will likely see your monthly payable interest gradually decrease over the life of your loan is because it is charged as a percentage of the amount owing. As you make repayments on your loan, you pay down the principal balance, thus reducing the amount owing on the loan.

Take Claudia, for example. Claudia decides to take out a personal loan to help cover the cost of furnishing her new home. After comparing loans and applying for her preferred product, she gets approved for a $15,000 loan with a fixed interest rate of 8 per cent and a loan term of three years.

Claudia’s monthly repayments are estimated to be $470. To figure out roughly how much of her first monthly repayment will go towards interest, she divides her interest rate by 12 (as interest rates are annual figures), and then multiplies it by her loan’s principal amount of $15,000.

  • Her equation looks like this: (0.08/12) x 15,000 = 100

This means that of her $470 repayment, $100 would cover interest charges and the remaining $370 would go towards paying down the principal balance.

If Claudia wanted to find out how much interest she would pay on her second repayment, she could use the same equation but with the remaining principal balance. As she will have paid it down by $370, the principal in her second month would be $14,630

  • Her equation would look like this: (0.08/12) x 14,630 = 97.53

As you can see, the interest charged in her second month of loan repayments is slightly less than her first month, due to the reduced principal balance. Keep in mind that these are approximate figures only, to show how interest is charged and can vary from one month to the next.

Here’s how the interest charges on Claudia’s first six months of repayments might look:

   Principal balance Repayment amount   Interest charged  Principal paid  Updated balance
 Month 1 $15,000 $470 $100 $370 $14,630
 Month 2 $14,630 $470 $97.53 $372.47 $14,257.53
 Month 3 $14,257.53 $470 $95.05 $374.95 $13,882.58
 Month 4 $13,882.58 $470 $92.55 $377.45 $13,505.13
 Month 5 $13,505.13 $470 $90.03 $379.97 $13,125.16
 Month 6 $13,125.16 $470 $87.50 $382.50 $12,742.66

Source: RateCity.com.au. Notes: This is an example only for the purpose of illustrating variations in interest.

How does interest vary on variable rate personal loans?

If your personal loan has a variable interest rate, the amount of interest you pay will not be fixed in advance and may instead be raised or lowered by your lender in accordance with the current economic conditions.

Calculating your interest charges on a variable rate personal loan can be trickier, but the calculations work much the same based on the interest rate at the time.

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Learn more about personal loans

Is a personal loan a variable or fixed-rate loan?

Depending on the personal loan lender, you may be able to choose between a fixed and a variable interest rate. But, there are a few distinct differences between the two, so it’s important to weigh up the pros and cons before deciding on what’s right for you.

A fixed interest rate loan gets you the convenience of knowing exactly how much you need to repay each fortnight or month. On the other hand, you generally won’t be able to make lump sum or advanced payments to close your personal loan early - or at least not without a penalty.

With a variable interest rate personal loan, you may be able to get a longer loan repayment term, with the option of paying off the loan early. You typically won’t need to pay any additional charges for an early full repayment either. The potential disadvantage with an interest rate that can change is that your repayment is not entirely predictable, as it can fluctuate with the market. However, you’ll likely have more options as more lenders offer a variable interest rate personal loan.

Should I get a fixed or variable personal loan?

Fixed personal loans keep your interest rate the same for the full loan term, while interest rates on variable personal loans may be raised or lowered during your loan term.

A fixed rate personal loan keeps your repayments consistent, which can help keep your budgeting consistent. You won't have to worry about higher repayments if your rates were to rise. However, on a fixed loan you’ll also potentially miss out on more affordable repayments if variable rates were to fall.

What is the average interest rate on personal loans for single parents?

Like other types of personal loans, the average interest rate for personal loans for single parents changes regularly, as lenders add, remove, and vary their loan offers. The interest rate you’ll receive may depend on a range of different factors, including your loan amount, loan term, security, income, and credit score.

What do credit scores have to do with personal loan interest rates?

There is a strong link between credit scores and personal loan interest rates because many lenders use credit scores to help decide what interest rates to offer to potential borrowers.

If you have a higher credit score, lenders will probably classify you as a lower-risk borrower. That means they’ll be keen to win your business, so they may offer you a lower interest rate if you apply for a personal loan.

If you have a lower credit score, lenders will probably classify you as a higher-risk borrower. That means they might be concerned about you defaulting on the loan and costing them money. As a result, they might protect themselves by charging you a higher interest rate.

Can you refinance a $5000 personal loan?

Much like home loans, many personal loans can be refinanced. This is where you replace your current personal loan with another personal loan, often from another lender and at a lower interest rate. Switching personal loans may let you enjoy more affordable repayments, or useful features and benefits.

If you have a $5000 personal loan as well as other debts, you may be able to use a debt consolidations personal loan to combine these debts into one, potentially saving you money and simplifying your repayments.

Can I merge my personal loan with my home loan?

Yes, you can refinance your home loan and, in the process, merge or consolidate your personal loan and home loan. By doing so, you can lower the number of debts you have, and you may also reduce the total interest you have to pay.

However, you should consult a financial advisor or a mortgage broker to confirm that you are decreasing your total outstanding debt, including interest payments. The repayment term for a home loan can be much longer than that for a personal loan, and by merging the two, you could be repaying a higher amount over the full term.

Are there any interest-free emergency loans?

The No Interest Loans Scheme (NILS) allows low-income borrowers to take out no-interest loans for up to $1500 to purchase essential goods and services.

There are also similar low-interest loan schemes available to borrowers in financial hardship who are having a tough time getting finance approved.

What is a bad credit personal loan?

A bad credit personal loan is a personal loan designed for somebody with a bad credit history. This type of personal loan has higher interest rates than regular personal loans as well as higher fees.

Can I repay a $3000 personal loan early?

If you receive a financial windfall (e.g. tax refund, inheritance, bonus), using some of this money to make extra repayments onto your personal loan or medium amount loan could help reduce the total interest you’re charged on your loan, or help clear your debt ahead of schedule.

Check your loan’s terms and conditions before paying extra onto your loan, as some lenders charge fees for making extra repayments, or early exit fees for clearing your debt ahead of the agreed term.

What interest rates are charged for personal loans?

Lenders aren’t allowed to charge interest on loans of $2,000 and under. Instead, they make their money by charging a one-off establishment fee of up to 20 per cent and a monthly account-keeping fee of up to four per cent. Lenders might also ask you to pay a government fee.

For loans between $2,001 and $5,000, lenders can make their money in only two ways: a one-off fee of $400 and annual interest rates of up to 48 per cent.

For loans of $5,001 and above, or for loans that have terms longer than two years, lenders can charge annual interest rates of up to 48 per cent.

Those fee caps don’t apply to loans offered by authorised deposit-taking institutions such as banks, building societies or credit unions, although such institutions are highly unlikely to charge interest rates of anywhere near 48 per cent.

How much can you borrow with a bad credit personal loan?

Borrowers who take out bad credit personal loans don’t just pay higher interest rates than on regular personal loans, they also get loaned less money. Each lender has its own policies and loan limits, but you’ll find it hard to get approved for a bad credit personal loan above $50,000.

Are there alternatives to $2000 loans?

If you need to borrow $2000 or less, alternatives to getting a personal loan or payday loan include using a credit card or the redraw facility of your home, car or personal loan.

Before you borrow $2000 on a credit card, remember that interest will continue being charged on what you owe until you clear your credit card balance. To minimise your interest, consider prioritising paying off your credit card.

Before you draw down $2000 in extra repayments from your home, car or personal loan using a redraw facility, note that fees and charges may apply, and drawing money from your loan may mean your loan will take longer to repay, costing you more in total interest.

Does refinancing a personal loan hurt your credit score?

Personal loan refinancing means taking out a new loan with more desirable terms in order to access a more competitive interest rate, longer loan term, better features, or even to consolidate debts.

In some situations, refinancing a personal loan can improve your credit score, while in others, it may have a negative impact. If you refinance multiple loans by consolidating these into one loan, it could improve your credit score as you’ll have only one outstanding debt liability. Your credit may also improve if you consistently pay the instalments on time.

However, applying to refinance with multiple lenders could negatively affect your credit if your applications are rejected. Also, if you delay or default the repayment, your credit score reduces.

What is a personal loan?

A personal loan sits somewhere between a home loan and a credit card loan. Unlike with a credit card, you need to sign a formal contract to access a personal loan. However, the process is easier and faster than taking out a mortgage.

Loan sizes typically range from several hundred dollars to tens of thousands of dollars, while loan terms usually run from one to five years. Personal loans are generally used to consolidate debts, pay emergency bills or fund one-off expenses like holidays.