Why Do Big Loans Have Lower Interest Rates, and Small Loans Have Higher Rates?
Hello, and welcome to another weekly edition of GrowthInshots!
Today, I want to discuss something that has probably crossed your mind at least once: Why do big businesses get loans at lower interest rates, while individuals seeking smaller personal loans are charged higher rates? The answer lies in a few core concepts of the banking and lending systems.
I know some of these terms might sound a bit complex, but I’ll break them down in the simplest way possible, with some real-time examples to help you understand them better. Let's dive in.
The Basics: What is Interest and Why Do Banks Charge It?
Before we get into the specifics, let’s understand what interest really is. When you borrow money, the lender (like a bank or financial institution) is taking a risk. The interest is essentially the price you pay for that loan, or in simpler terms, the fee you pay for the privilege of borrowing money.
Think about it like this: You want to buy something worth ₹50,000, but you don’t have the full amount right now. You borrow ₹50,000 from the bank and agree to pay it back with interest over time. That extra money you pay back is the interest.
Now, the rate at which the bank charges interest depends on a lot of things. One of the most important factors is how risky the bank thinks it is to lend you the money. The higher the risk, the higher the interest rate they’ll charge you.
Why Do Businesses Get Lower Interest Rates?
So, you’re probably wondering why big businesses are charged lower interest rates than individuals who borrow smaller amounts. There are several reasons for this, and I’ll go through them one by one.
1. Businesses Have More Collateral
Collateral is something of value that the borrower offers to the lender to guarantee the loan. If the borrower fails to repay the loan, the lender can take the collateral to recover the money.
Big businesses often have substantial assets—such as buildings, machinery, or even stock inventory— to offer as collateral. This makes them less risky for banks. If the business defaults on the loan, the bank can recover the money by selling the collateral.
On the other hand, personal loans (like the ones you or I might take out) are usually unsecured. This means that there’s no physical asset backing the loan. If you default on an unsecured loan, the bank doesn’t have much to fall back on. This is why personal loan interest rates tend to be higher.
2. Business Loans are Larger, So They Spread the Risk
Let’s say a bank gives a company a loan of ₹1 crore (₹10 million). The bank might not have to do a lot of administrative work for such a large amount because the business might have a well-established financial structure and clear repayment plans. Moreover, the loan amount is spread across a long-term period, reducing the risk for the bank.
In contrast, personal loans are often smaller and may come with shorter repayment periods, which can result in higher interest rates. The bank also spends more time processing and managing multiple small loans, which increases costs.
3. Businesses Are More Likely to Repay
Banks often assess the likelihood of repayment before offering a loan. Large businesses tend to have steady income streams and established reputations. They can show their financial performance and prove that they’re capable of repaying the loan over time. This gives banks confidence, and they reward these businesses with lower interest rates.
For example, let’s look at current lending rates in India.
For a business loan of ₹1 crore (₹10 million), the interest rates can range between 7% and 12% annually, depending on the business's financial health, collateral, and the loan's term. The more stable the business, the lower the interest rate.
However, for a personal loan of ₹1 lakh (₹100,000), the interest rates can range from 12% to 24% annually, depending on factors like credit score, income, and repayment history.
4. Banks Are Willing to Lend More to Big Companies
Big businesses usually have an easier time getting approved for loans because they meet the criteria set by banks. These businesses have strong balance sheets, a history of profitability, and the ability to show future cash flows that can cover the loan repayment. As a result, banks feel comfortable offering them loans at lower interest rates.
5. Government and Policy Support
In many countries, including India, the government provides various schemes to promote business growth, especially for MSMEs (Micro, Small, and Medium Enterprises). These schemes often include lower interest rates or interest subsidies. For example, the Pradhan Mantri Mudra Yojana (PMMY) offers loans to small businesses with interest rates as low as 7% per annum.
Why Do Personal Loans Have Higher Interest Rates?
Now, let’s talk about why personal loans are charged higher interest rates, despite being smaller amounts.
1. Risk of Default is Higher with Individuals
When individuals take out loans, banks can’t rely on collateral or the established financial stability that businesses offer. Personal loans are often unsecured, which means no property or asset is backing up the loan.
If someone loses their job, faces an emergency, or has a sudden financial setback, they might not be able to repay the loan. As a result, banks increase the interest rates to compensate for the higher risk of lending money to individuals.
2. Smaller Loan Amounts Mean More Administrative Work
Banks also incur fixed costs to process loans. When someone takes out a small loan of ₹50,000 or ₹1 lakh, the bank still has to perform tasks like credit checks, documentation, and loan monitoring. These fixed costs are the same whether the loan is ₹50,000 or ₹50 lakh.
Since smaller loans generate less revenue for the bank, they raise the interest rates to make it financially viable for them to lend out smaller amounts.
3. Credit Score Plays a Bigger Role
Banks rely heavily on your credit score when deciding whether to lend money to you. Your credit score reflects your history of borrowing and repaying money. The higher your score, the more likely you are to get a personal loan at a lower rate.
If your credit score is low, the bank sees you as a higher risk and will charge you a higher interest rate to make up for that risk.
Real-Time Data: Comparing Business Loans and Personal Loans
Let's delve into the current interest rates for business and personal loans in India, providing a clearer picture of the financial landscape.
Business Loan Interest Rates:
As of January 2025, business loan interest rates in India vary based on the lender, loan amount, and the borrower's credit profile. Here's an overview:
Public Sector Banks:
Bank of Baroda: Offers business loans with interest rates ranging from 10.20% to 15.45% per annum, depending on the loan type and tenure. forbes.com
Punjab National Bank: Provides MSME loans at interest rates between 9.40% to 10.65% per annum. forbes.com
Private Sector Banks:
HDFC Bank: Offers business loans with interest rates starting from 10.75% per annum. forbes.com
ICICI Bank: Provides business loans at interest rates of around 13% per annum. forbes.com
Non-Banking Financial Companies (NBFCs):
Lendingkart: Offers business loans with interest rates starting from 1.25% per month, which translates to approximately 15% per annum. lendingkart.com
Personal Loan Interest Rates:
Personal loan interest rates in India also vary based on the lender, loan amount, and the borrower's creditworthiness. Here's a snapshot:
Public Sector Banks:
State Bank of India (SBI): Offers personal loans with interest rates ranging from 11.45% to 14.60% per annum. forbes.com
Bank of Baroda: Provides personal loans at interest rates starting from 11.05% per annum. Paisabazaar
Private Sector Banks:
ICICI Bank: Offers personal loans with interest rates starting at 10.85% per annum. ICICI Bank
HDFC Bank: Provides personal loans with interest rates starting from 10.75% per annum. HDFC Bank
NBFCs:
Money View: Offers personal loans with interest rates starting from 1.25% per month, which translates to approximately 15% per annum. Money View
for detailed information on current interest rates for business and personal loans in India, specifically sourced from the Reserve Bank of India (RBI).
Let's explore this topic comprehensively and straightforwardly.
Understanding Interest Rates in India: A Personal Perspective
Imagine you're considering taking out a loan. Whether it's for expanding your business or managing personal expenses, the interest rate significantly influences your decision. In India, these rates vary based on the type of loan and the lender. Let's break it down.
Business Loans:
As a business owner, securing financing is crucial. According to the RBI's data up to November 2024, the weighted average lending rate (WALR) on fresh rupee loans from scheduled commercial banks (SCBs) stood at 9.40%. rbi.org.in
However, this is an average. The actual rate you might receive depends on several factors:
Loan Amount: Larger loans may attract different rates compared to smaller ones.
Creditworthiness: Your business's financial health and credit history play a significant role.
Lender Type: Public sector banks, private sector banks, and non-banking financial companies (NBFCs) may offer varying rates.
Personal Loans:
When it comes to personal loans, the scenario is similar. The RBI's data indicates that the WALR on outstanding rupee loans was 9.89% as of November 2024. rbi.org.in
But again, this is an average. Your loan rate will depend on:
Credit Score: A higher score often leads to better rates.
Income Stability: Lenders assess your ability to repay based on your income.
Loan Tenure: Shorter loan periods might have different rates compared to longer ones.
Why the Difference in Rates?
You might wonder, why do these rates differ? Here's a simple explanation:
Risk Assessment: Lenders evaluate the risk associated with each loan. Business loans, especially for startups, might be considered riskier than personal loans, leading to higher interest rates.
Loan Purpose: The loan's intended use can influence the rate. For instance, loans for business expansion might have different rates than those for personal expenses.
Economic Factors: Broader economic conditions, such as inflation and monetary policy, also impact interest rates. For example, the RBI's monetary policy decisions directly affect the rates at which banks lend to each other, which in turn influences the rates offered to customers.
A Personal Story:
Let me share a brief story to illustrate this. A friend of mine, I call him Raj, wanted to expand his small manufacturing business. He approached a bank for a loan. The bank assessed his business plan, financial statements, and credit history. Based on this evaluation, they offered him a loan at an interest rate of 10%. Raj was pleased with the rate, as it was competitive and aligned with his financial projections.
In contrast, his cousin, Priya, needed a personal loan for a family event. She approached the same bank. The bank reviewed her credit score, income stability, and existing obligations. They offered her a loan at an interest rate of 12%. While higher than Raj's rate, it was still within the market range for personal loans.
How Can You Get a Lower Interest Rate on Your Loan?
If you’re an individual looking to secure a loan at a lower interest rate, there are a few things you can do:
Improve Your Credit Score: A higher credit score can significantly lower your interest rate. Make sure to pay off existing debts, avoid missing payments, and manage your finances well.
Consider a Secured Loan: If you have valuable assets like property, you can pledge them as collateral. This reduces the risk for the lender and can help you secure a loan with a lower interest rate.
Compare Loan Offers: Don’t settle for the first offer you get. Compare loan offers from different banks and financial institutions to find the best rates.
Opt for Longer Loan Tenure: Sometimes, you can negotiate a longer loan tenure to lower your EMI (equated monthly installment) and make the loan more affordable. Just remember that a longer tenure means more interest paid over time.
In simple terms, interest rates for business and personal loans in India vary based on factors like loan size, purpose, and credit profile. Business loans tend to have more flexible rates, depending on the perceived risk, while personal loans generally have slightly higher rates but are more accessible. The RBI influences these rates through its monetary policies.
To make the best choice, it’s essential to compare offers, monitor your credit score, and ensure the loan suits your financial situation. Knowledge is key when securing the best deal for your future, whether it’s for business growth or personal needs.
Thanks for reading, and stay tuned for more insights on GrowthInshots!
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