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Why Low Interest Rates Don’t Tell the Full Story of Personal Loans

Personal loans are often marketed with attractive interest rates, especially through mobile notifications and pre-approved offers. Many borrowers see figures like 10% or 11% and immediately consider taking the loan, believing it to be a good deal. However, once you look deeper, the actual cost can be significantly higher than what the headline interest rate suggests. Banks and non-banking financial companies (NBFCs) apply several additional charges that borrowers often overlook, leading to a far more expensive loan than expected.

A Small Rate Increase Can Mean a Big Financial Difference

Most customers evaluate personal loans primarily on the interest rate. But even a small difference in the rate can substantially impact the total repayment amount.

Take this example:
If you borrow ₹5 lakh for three years at an interest rate of 11%, the total interest paid over the tenure comes to approximately ₹89,296. But if the rate increases to 13%, the total interest jumps to nearly ₹1,06,491. That means you end up paying ₹17,195 more simply because the rate increased by just 2%.

This illustrates why borrowers should not accept loan offers without understanding the complete cost structure.

Processing Fees: One of the Biggest Hidden Costs

While the interest rate gets all the attention, processing charges are among the most common additional costs that borrowers forget to include in their calculations.

Most banks and NBFCs charge a processing fee upfront when disbursing a personal loan. This amount is deducted before the loan is transferred to your account. For example, if you were approved for a ₹5 lakh loan with a processing fee of 2%, you would receive only ₹4.9 lakh in your bank account, even though you repay the full ₹5 lakh plus interest.

This upfront fee increases your effective cost, but many borrowers overlook it because it is not included in the interest rate.

Prepayment Charges Add Another Layer of Cost

Another important charge is the prepayment or foreclosure penalty. If you wish to repay your personal loan before the scheduled tenure—whether partially or fully—banks may impose fees ranging from 2% to 5% of the outstanding amount.

Borrowers usually plan early repayment to save on interest, but the penalty can reduce or even cancel out those savings. Before accepting any loan offer, it is essential to check how much prepayment penalty the lender charges.

How Banks Decide Your Interest Rate

The rate offered to you is not random. Banks and NBFCs evaluate your credit profile before deciding your interest rate. They consider:

• Credit score (CIBIL score)

• Employment stability and job profile

• Past loan repayment record

A strong credit history can help you secure a much lower interest rate. But if your score is average or poor, lenders will offer a significantly higher rate—even for the same loan amount and tenure. In urgent financial situations, borrowers often accept such costly loans without negotiation, enabling lenders to take advantage of their vulnerability.

Questions You Must Ask Before Accepting a Loan Offer

Before saying yes to any personal loan offer, make sure you ask your lender these questions:

1. What is the total processing fee?
   This should be clarified upfront, including GST.

2. What are the prepayment or foreclosure charges?
   This determines how flexible your repayment options will be.

3. Can the processing fee be waived?
   Many lenders offer waivers for customers with an excellent credit score.

4. Is the quoted interest rate fixed or floating?
   This affects how your EMI may change in the future.

Bottom Line

A low interest rate may seem appealing, but personal loans involve several additional charges that can substantially increase your overall borrowing cost. By understanding processing fees, prepayment penalties, and how lenders assess your credit profile, you can make a smarter borrowing decision and avoid unnecessary financial burden.