How Does Interest Work on a Personal Loan?

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When you take out a personal loan, your interest payment is generally fixed. This means you’ll have equal monthly payments factoring in the amount of interest you owe on top of the funds you borrow, which you’ll need to make until the loan is paid off.

Your personal loan annual percentage rate (APR) includes both the interest rate you’ll be charged to borrow money and any additional fees, so it represents the total cost of borrowing from a lender. Your exact APR will be determined by your credit score, with higher scores qualifying for lower rates.

It’s important to understand how interest works if you’re researching how to get a personal loan. Keep reading for more details.

Fixed vs. Variable Interest Rates on Personal Loans 

Most personal loans are fixed-rate, meaning the interest rate stays the same for the duration of the loan. These are the most comon types from major banks and online lenders.

Variable-rate loans are also available, though less common. With these, your interest rate can flutuate according to market conditions.

Here’s a side-by-side look at how fixed and variable interest rates compare:

How Interest Is Calculated on Personal Loans 

There are pros and cons of personal loans, and one disadvantage you can’t get around is that you’ll have to pay interest to borrow money. There are a few different ways to calculate interest on a loan, but most personal loans use simple interest.

How Simple Interest Works

Simple interest is calculated with this basic formula:

Interest = Principal x Interest Rate x Time

Note that there’s a difference between interest rate and APR. APR is a more accurate picture of how much you’ll pay to borrow money, because it includes both your interest rates and any other fees, such as loan origination fees.

An Example of a Simple Interest Calculation

Here’s a look at how simple interest would work on a personal loan:

• Your loan is $10,000
• The APR is 10%
• It’s a 3-year term.

According to the formula, the simple interest calculation would be ($10,000 x 0.10 x 3), suggesting that the interest would be $3,000.

This means you’d pay $3,000 to borrow the $10,000, for a total repayment amount of $13,000.

An important note: With a simple interest loan, you only pay interest on the outstanding principal balance of your loan.

• Your balance will decrease with every monthly payment you make.
• The simple interest calculation will change as you pay off more of the loan.

This means you’d pay less than the original $3,000 calculated above to borrow $10,000, with the exact amount depending on the size and the frequency of your loan payments.

What Is a Good APR on a Personal Loan? 

You can evaluate whether you’re getting a good APR on your personal loan by knowing what the average rates look like for different credit buckets. Here’s what you should expect in the different credit score ranges:

• Excellent credit: 6% to 10% APR 
• Average credit: 11% to 20% APR 
• Poor credit: 20% and above APR

What To Look for When Shopping for a Personal Loan

Keep these rules of thumb in mind:

• Don’t go for the first option you come across.
• Compare rates from banks, credit unions and online lenders to find the most favorable terms.
• Look at APR, rather than the interest rate, to get the fullest picture of your borrowing cost.

What Affects the Interest Rate You Get? 

Your credit score is the biggest factor in determining the personal loan interest rate you qualify for, as it represents your credit risk and the likelihood that you’ll pay the loan back on time.

Other factors figure into your interest rate as well, including:

• Your income
• Employment status
• The amount of money you’re borrowing
• Lender type
• The length of the loan term, with lower amounts and shorter terms qualifying for lower rates than larger amounts and longer terms.

Credit unions tend to offer lower rates, especially to those with middling credit, compared to traditional banks.

Average Personal Loan Interest Rates in 2025 

All interest rates are influenced by the larger market and economic environment and shift based on the Federal Reserve’s target federal funds rate. This means that average loan rates can look quite different on a yearly, or even monthly, basis.

According to the Federal Reserve Bank of St. Louis (FRED), the average personal loan rate available at banks was 11.66% APR, as of Apr. 7, 2025. This is considered an average, however, and rates vary by lender and loan type, so always shop around. 

How To Lower Your Personal Loan Interest Rate 

To ensure you get the best personal loan rate possible, the best thing you can do is improve your credit score. Taking out a loan and making on-time payments can improve your credit in the long run. You should also check your credit report for any errors and aim to keep your credit utilization low.

To get the lowest rate, you can also look at shorter loan terms and consider applying with a co-signer who has a strong credit score. Choosing a secured personal loan can get you a lower rate as well, as this type of loan requires collateral up front, which makes the transaction less risky for the lender.

Don’t forget to compare offers from multiple lenders. This is the best way to secure the lowest rate possible.

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