Interest Rates: Meaning, Types and How They Work?

Interest Rates: Meaning, Types and How They Work?

Interest rates are the cost of borrowing, expressed as a percentage of the loan amount. Bajaj Finance Personal Loan interest rates range from 10% and 30.5% p.a., subject to eligibility. Check your loan offer to see the interest rate applicable to you.
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Key takeaways


An interest rate is the cost of borrowing money, expressed as a percentage of the loan amount. Understanding how interest rates work helps you compare loan offers and estimate your total borrowing cost.


  • Interest rates affect your EMI and the total amount you repay.
  • Bajaj Finance personal loan interest rates range from 10% and 30.5% p.a., subject to eligibility.
  • Fixed, variable, simple, and compound interest rates work differently.
  • Credit score, loan tenure, income, and RBI policy can influence the interest rate offered.

The interest rate is one of several factors to consider when assessing the overall cost of a personal loan.

What are interest rates?

Interest rates represent the cost of borrowing money or the return earned on savings over a specific period. For a loan, the interest rate is the percentage charged on the borrowed amount in addition to the principal. The applicable interest rate affects your EMI and the total amount you repay. For Bajaj Finance Personal Loans, interest rates range from 10% and 30.5% p.a., subject to eligibility. Factors such as credit score, income, loan tenure and repayment capacity can influence the applicable rate. Understanding how interest rates work can help you estimate borrowing costs and compare loan options.



✅ Check your pre-approved loan offer with phone number and OTP → Check your loan terms, including interest rates → Apply online in 5 minutes.

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How do interest rates work?

Loan interest rates determine the cost of borrowing by applying a percentage to the loan amount over the repayment period. The interest charged is calculated on the outstanding principal, and together with the loan tenure, it determines your EMI and total repayment. Higher interest rates increase the overall borrowing cost, while lower rates reduce it. The rate offered depends on factors such as your credit score, income, repayment capacity, loan tenure, and market conditions.


For example, if you borrow Rs. 5 lakh at 12% p.a. for 5 years, the interest is calculated on the outstanding principal as you repay the loan. The EMI includes both principal and interest. Bajaj Finance Personal Loan interest rates range from 10% and 30.5% p.a., subject to eligibility.


You can check your eligibility using only your mobile number and OTP, without visiting a branch.

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Types of interest rates

There are different forms of interest rates, here’s all about them and how they work:

Fixed Interest Rate:

The most common type of interest rate is a fixed rate, which is usually what the lender charges the borrower of a personal loan. As the name suggests, the interest rate stays the same throughout the loan's repayment period.


Advantage: Predictable EMIs—you know exactly how much to pay every month.


When used: Commonly used for personal loans and car finance.

 

Variable Interest Rate:

A variable interest rate is the opposite of a fixed interest rate. In this situation, the interest rate changes over time based on several factors like the repo rate. Variable interest rate is typically linked to changes in the base interest rate, also known as the prime rate of interest.


Advantage: Can be lower initially, potentially saving money if rates fall.

Risk: EMI can increase if market rates rise.

When used: Typically seen in home loans.


Compound interest rate

A compound interest rate calculates interest on the principal amount and the interest accumulated over time. This means the interest amount can increase as previously accrued interest is added to the balance.


Key point: Compound interest may be used with fixed or floating interest rates, depending on the loan product.

Cost: It can result in higher borrowing costs because interest is calculated on accumulated interest.


Compound interest formula:

A = P × (1 + r/n)^(nt)


Where:

  • A = Amount accumulated after t years, including interest
  • P = Principal amount
  • r = Annual interest rate in decimal form
  • n = Number of times interest is compounded per year
  • t = Time in years

You can calculate compound interest using a compound interest calculator or the formula above.

 

Simple interest rate

A simple interest rate is calculated only on the original principal amount. The interest remains based on the initial amount throughout the specified tenure and does not include previously accrued interest.


Note: Simple interest is generally less common for personal loans.


Simple interest formula:

I = P × r × t


Where:

  • I = Interest amount
  • P = Principal amount
  • r = Rate of interest in decimal form
  • t = Time in years

You can calculate simple interest using a simple interest calculator or the formula above.


Also read: Flat vs reducing interest rate

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How do interest rates affect loan repayments?

Loan interest rates directly affect your monthly EMI and the total amount you repay over the loan tenure. A lower interest rate generally reduces your EMI and overall borrowing cost, while a higher rate increases both. The exact impact depends on the loan amount, interest rate, and repayment tenure.


  • Higher loan interest rates increase your monthly EMI or the total interest paid over the loan tenure.
  • Lower loan interest rates can make repayments more affordable.
  • A longer loan tenure may reduce the monthly EMI but can increase the total interest payable.
  • Comparing interest rates and loan terms helps you estimate your repayment obligations before applying.
  • Using an EMI calculator can help you understand how different interest rates affect your monthly instalments.

Review the interest rate, tenure, and applicable charges together to make an informed borrowing decision.

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How interest rates influence the cost of borrowing?

An interest rate is a cost to the borrower and a source of income for the lender. The interest rate applied to a loan affects the borrowing cost and helps lenders price loans based on factors such as credit profile, loan tenure, and market conditions. 


For example, on a Rs. 5 lakh loan with a 3-year tenure, the EMI is approximately Rs. 16,134 at 10% p.a. and approximately Rs. 18,584 at 20% p.a. This difference highlights why comparing Bajaj Finance Personal Loan interest rates and applicable charges is important before applying. 


 Read about all the personal loan interest rate, fees and charges to make an informed decision.

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Reasons for changes in interest rates

Interest rates don't remain static—they change based on various economic and political factors:

1. Short-term political gain

Lowering interest rates can give a short-run boost to the economy and may influence voter sentiment. However, most economists believe this effect is temporary and will be cancelled out by inflation.
 

2. Expectations of inflation

Interest rates are heavily influenced by expectations about inflation. Higher inflation expectations cause rates to rise, whilst lower expectations cause rates to fall. Central banks regularly track and adjust rates based on inflation targets.
 

3. Taxation changes

Taxes affect interest rates by changing supply and demand for loans. When taxes increase, loan demand may decline, leading to lower rates. When taxes decrease, disposable income rises, increasing loan demand and potentially raising rates.
 

4. Economic conditions

Interest rates vary based on overall economic health. Rates tend to rise during strong economic periods and fall during weak economies as lenders and borrowers adjust behaviour accordingly.

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Factors determining personal loan interest rate

The loan interest rate you are offered is influenced by multiple factors—both economic and institutional. Whilst broader economic conditions like inflation, fiscal deficits, and stock market trends play a central role, other elements such as global investment flows and monetary policies also affect how rates are set.


Reserve Bank of India (RBI) Policy Stance

One of the key drivers is the policy stance of the RBI. When the central bank increases the present interest rate, borrowing becomes more expensive for lenders. This leads to a rise in the loan interest rate offered to consumers. As the cost of borrowing goes up, both personal and business loans tend to decline.


Your Credit Score

A higher credit score signals better creditworthiness, often resulting in lower interest rates. Conversely, a lower score typically means higher rates.


Loan Tenure

Longer loan tenures typically attract higher interest rates due to increased risk exposure for the lender.


Employment Type

Salaried employees, especially those with government jobs or MNC employment, often qualify for lower rates due to stable income.


Existing Relationship with Lender

Existing customers with good repayment history may receive preferential rates compared to new applicants.


Economic Indicators

Inflation rates, GDP growth, market trends, and global economic conditions all influence how lenders set their interest rates.


How lenders use economic indicators

Economic indicators such as inflation, market interest rates, and monetary policy can influence the interest rates and APRs offered on loans. Lenders consider these factors along with the borrower’s credit profile, income, repayment capacity, loan tenure, and applicable charges when determining loan terms.


Comparing APRs and interest rates across loan offers can help you assess the overall cost of borrowing. Even a small difference in the applicable interest rate can affect the total interest paid over the loan tenure, particularly for larger loan amounts or longer repayment periods.


Important: Consider the interest rate, applicable fees, loan tenure, EMI, and total repayment amount when comparing loan offers..

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Difference between APR and APY

Consumer loan interest rates are usually given as the Annual Percentage Rate (APR). This is the rate of return that lenders want in exchange for lending their money. On the other hand, the interest rate on a savings account or cash deposit at a bank or NBFC is called the Annual Percentage Yield (APY). Compounding is taken into consideration in this interest rate.



  • APR (Annual Percentage Rate): The annual cost of borrowing, including interest and applicable charges. It represents what you pay for a loan.
  • APY (Annual Percentage Yield): The annual return earned on savings or deposits, including the effect of compound interest.

APR is generally used for loans, while APY is used for savings and deposits. APR helps you understand the cost of borrowing, whereas APY shows the potential return on money saved or invested.


Why it matters: The two rates serve different purposes. APR focuses on the cost of borrowing, while APY accounts for compounding when showing the annual return on savings.

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How to make informed borrowing decisions based on interest rates?

Choosing the right loan involves more than comparing interest rates. Consider the following factors before applying:


  • Compare interest rates offered by different lenders to understand the borrowing cost.
  • Check the Annual Percentage Rate (APR), as it may include applicable fees and charges.
  • Review the loan tenure, since it influences your EMI and the total interest payable.
  • Evaluate all applicable charges, such as processing fees, foreclosure charges, and part-prepayment charges.
  • Assess your repayment capacity by choosing an EMI that fits your monthly budget.
  • Read the loan terms carefully before accepting the loan offer.

Comparing these factors can help you choose a loan that suits your financial requirements.

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Key offerings: 3 loan types

  • Flexi Hybrid Loan
  • Flexi Dropline Loan
  • Term Loan

  • Withdraw and prepay – no extra charges
    You can withdraw from your limit and prepay as many times as you want, without extra charges.

  • Instalment pattern
    You can pay interest-only EMIs for up to 36 months, after which, the EMI will consist of both, the principal and the interest. EMI is applicable only on the withdrawn amount.

  • Flexi facility charges
    Flexi facility charges applicable based on your loan amount.

  • Withdraw and prepay – no extra charges
    You can withdraw from your limit and prepay as many times as you want, without extra charges.

  • Instalment pattern
    Fixed EMIs that cover both the principal and interest on the loan amount you withdraw.

  • Flexi facility charges
    Flexi facility charges applicable based on your loan amount.

  • Amount disbursed in one go
    The entire loan amount is disbursed at the start.

  • Instalment pattern
    Fixed EMIs that cover both the principal and interest.

  • Flexi facility charges
    No Flexi facility charges.

Personal loan interest rate and applicable charges

Type of fee

Applicable charges

Rate of interest per annum

10% to 30.5% p.a.

Processing fees

Up to 4.13% of the loan amount (inclusive of applicable taxes).

Flexi Facility Charge

Term Loan – Not applicable

Flexi Loans –Up To Rs 1,999 To Up To Rs 18,999/- (Inclusive Of Applicable Taxes)

Will be deducted upfront from loan amount.

Bounce charges

Rs. 700 to Rs. 1,200/- per bounce

“Bounce charges” shall mean charges for (i) dishonor of any payment instrument; or (ii) non-payment of instalment (s) on their respective due dates due to dishonor of payment mandate or non-registration of the payment mandate or any other reason.

Part-prepayment charges

Full Pre-payment:

  • Term Loan: Up to 4.72% (Inclusive of applicable taxes) on the outstanding loan amount as on the date of full pre-payment

  • Flexi Term (Dropline) Loan: Up to 4.72% (Inclusive of applicable taxes) on the outstanding loan amount, as on the date of full prepayment.

  • Flexi Hybrid Term Loan: Up to 4.72% (Inclusive of applicable taxes) on the outstanding loan amount, as on the date of full prepayment.

Part Pre-payment

  • Up to 4.72% (Inclusive of applicable taxes) of the principal amount of Loan prepaid on the date of such part Pre-Payment.

  • Not Applicable for Flexi Term (Dropline) Loan and Flexi Hybrid Term Loan.

Penal charge

Delay in payment of instalment(s) shall attract Penal Charge at the rate of up to 36% per annum per instalment from the respective due date until the date of receipt of the full instalment(s) amount.

Stamp duty (as per respective state)

Payable as per state laws and deducted upfront from loan amount.

Annual maintenance charges

Term Loan: Not applicable

Flexi Term (Dropline) Loan:

Up to 0.295% (Inclusive of applicable taxes) of the Dropline limit (as per the repayment schedule) on the date of levy of such charges.


Flexi Hybrid Term Loan:

Up to 0.472% (Inclusive Of Applicable Taxes) Of The Dropline Limit During Initial Tenure. Up to 0.295% (Inclusive Of Applicable Taxes) Of Dropline Limit During Subsequent Tenure

Credit guarantee scheme feeUp to 1.18% p.a. (pro-rated daily till 31st March) (inclusive of all applicable taxes) of the loan amount
Credit guarantee scheme renewal feeUp to 1.18% p.a. (inclusive of all applicable taxes) on the outstanding loan amount as on April 01 of the subsequent Financial Year.
*Renewal Fee to be collected only for 3 subsequent financial years.
 
**If the Remaining Tenure is less than 12 months, the CG Fee in subsequent years shall be charged prorated.

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Frequently asked questions

Overview

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Meaning

Charges

Is 12% a good interest rate on personal loan?

Whether 12% is a good personal loan interest rate depends on factors like credit score, loan term, and market rates. It's advisable to compare offers.

To calculate interest rate, divide the interest amount by the principal amount and multiply by 100, or use formulas like simple or compound interest based on context.

To calculate 8% interest on a loan, simply use the personal loan EMI calculator available on the Bajaj Finance website.

An interest rate is the percentage charged or earned on a principal amount of money over time. It represents the cost of borrowing money or the return on savings.

It’s called an interest rate because it represents the “interest” or extra amount paid over the principal amount borrowed or invested. It compensates lenders or investors for the opportunity cost.

The main features of interest include being the cost of borrowing money, calculated as a percentage over time. It is influenced by factors such as inflation, economic conditions, and central bank policies, reflecting the price of using funds.

The interest rate formula is: Interest Rate (r) = (Interest Amount / Principal) × 100%. It calculates the percentage of the principal paid as interest over a specific period.

The different types of interest include simple interest, compound interest, fixed interest, and floating interest—each calculated differently depending on the loan or investment terms.

The difference between bank rate and interest rate lies in their purpose—bank rate is charged by the central bank to commercial banks, while interest rate applies to loans for individuals.

High interest rates mean lenders charge a higher percentage on borrowed money. This increases the cost of borrowing and can result in higher EMIs or a higher overall borrowing cost, while savings and deposits may earn higher returns.

Interest rate risk is the possibility that changes in interest rates may affect the value or cost of a loan, investment, or financial product. It can influence borrowing costs, investment returns, and the market value of fixed-income securities.

A negative interest rate means the interest rate is below 0%, where certain deposit holders may be charged to keep money with a financial institution instead of earning interest. This is an uncommon monetary policy used in some countries and is generally not applicable to personal loans in India.

Personal loans may have fixed or variable interest rates, depending on the loan product. The applicable rate can vary based on factors such as credit profile, income, loan tenure, repayment capacity, and applicable terms.

Switching from a higher to a lower interest rate may depend on the loan terms and available options. Borrowers should check their loan agreement and applicable terms to determine whether a rate change is permitted.

The processing fee is generally a separate charge from the stated interest rate. It can form part of the overall borrowing cost, so borrowers should review the applicable fees, charges, and loan terms before accepting the loan.

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