How your loan amount affects the interest rate

If you took out a personal loan of £4,500, would you expect the interest you pay back to be:

A. less than if you borrowed £5,000?
B. the same as if you borrowed £5,000?
C. more than if you borrowed £5,000?

You might be surprised to learn that the correct answer is C.

You’d be forgiven for thinking that if you were borrowing less money, you’d pay a lower interest rate, but more often than not this isn’t the case. Here, uSwitch explains how and why loan interest rates are affected by the amount you want to borrow.

The impact of loan amount on loan APR

While most of us have an idea that the amount you want to borrow will have an impact on the interest rate you pay, the ins and outs of loan interest rates can come as a surprise.

As in the example given above, if you wanted to borrow £4,500, when we did our test in December 2009, the best APR on the market was 12.9% – meaning you’d pay back £1,533 in interest over a 5 year term.

However, if you borrowed £5,000 instead, you could get an APR of 8.8%, so you’d pay back £1,150 in interest over the same term. So, you end up paying back £383 more in interest for borrowing £500 less.

Why you pay a higher APR for a smaller loan

Why? It’s not always clear, but generally speaking, the APR that a lender sets for a loan is an indication of the risk the company feels it is taking and of the likelihood they think they have of getting their money back. It could be that loan companies see the need to borrow smaller amounts as an indication that the borrower doesn’t have any savings to fall back on, and is therefore less responsible with their personal finances.

When you think about the wider borrowing market, it starts to fall into place – think about mortgages, which typically have a high loan amount and lower interest rates, while at the other end of the scale, payday loans are generally for very small amounts but have huge APRs.

How to get a better loan rate

When you’re looking for a loan, checking what APRs are available for a few different loan amounts. You might find that by borrowing more, you can reduce the amount you pay back in interest. If you’re worried about the temptation of borrowing more money than you really need, you could put the extra money into a savings account or, if there’s no penalty, pay the excess back straight away. Compare loans now.

Alternatively, if you’re looking to borrow a small amount of money, read our article on small loans to find out more and see what different options are open to you.