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Today, the Federal Open Market Committee voted to cut the federal funds rate for the first time in four years. This benchmark interest rate affects how much it costs lenders to make loans, and therefore affects interest rates on consumer loans, including personal loans.
Still, Greg McBride, chief financial analyst at Bankrate, expects the changes to have a minimal immediate impact on personal loans.
“You’ll find the best terms if you have good credit and shop around for different lenders, but that won’t necessarily change with the Fed,” McBride said.
How will the Fed affect personal loans?
The federal funds rate affects lenders’ costs, and therefore the interest rates that lenders offer to new borrowers. Higher interest rates mean higher lending costs. As the Fed implemented interest rate hikes for 2022-23, the average interest rate on personal loans has also increased. The average interest rate on personal loans was 10.28% at the beginning of 2022 and has been steadily increasing since then. As of September, the average personal loan interest rate is 12.42%.
However, at the end of the September FOMC meeting, the committee announced that it would cut interest rates by 50 basis points, setting a new target range of 4.75% to 5%. The move came after several months of subdued inflation.
While individual lenders may begin lowering interest rates in anticipation of further cuts in the federal funds rate, industry averages remain at record highs.
Federal Reserve Impact on Existing Loans
The vast majority of personal loans are fixed-rate loans, which means the interest rate stays the same from the time you take out the loan until you pay it off. If you have a fixed-rate personal loan, your interest rate and monthly payment will stay the same even if the Fed raises or lowers interest rates.
This means that if you sign up for a low, fixed-rate personal loan, your interest rate will not fluctuate based on the federal rate.
Will interest rates on personal loans start to fall?
The short answer is, yes, but it will take time and the first to benefit will be borrowers with good to excellent credit. Some consumer loan rates, such as mortgage rates, have already fallen ahead of the cuts.
But McBride points out that “consumer loan rates have not been particularly interest-rate sensitive during previous rate-cutting and -hiking cycles, and rates for highly creditworthy borrowers have moved within a much narrower range than the Fed’s movements.”
Mark Hamrick, senior economic analyst and Washington bureau chief at Bankrate, said the cut would likely be the first in a “steady series of cuts” in late 2024 and early 2025. He echoed McBride’s sentiment that the impact is unlikely to be immediate.
“Interest rates have risen sharply in the wake of historically high inflation, and it will take time for most of that to go away,” Hamrick said. “As a result, borrowing rates will take time to come down significantly.”
McBride doesn’t think waiting will have a big impact on the interest rates personal loan borrowers receive.
“The reality for many personal loan borrowers is that they take out a loan because they need the money urgently,” he points out. “Waiting for interest rates to drop may not be an option, and the savings from doing so may not be significant. On a $5,000, three-year loan, a 1 percent difference in interest rate would mean less than $3 in monthly interest and less than $100 in total interest over the term.”
How can you get an affordable loan despite the high interest rates?
Interest rates on personal loans are high right now, but the federal rate isn’t the only factor that affects the cost of a loan. Taking some steps, like improving your credit score and applying with a co-borrower, can help you get the best possible terms.
“This is where shopping around for different lenders can really pay off,” McBride added.
Here are some steps you can take to ensure you get the best possible terms on your personal loan.
Conclusion
Because personal loans are fixed-rate products, current borrowers are not affected by Federal Reserve interest rate changes. Interest rates on new loans are unlikely to plummet anytime soon, but new borrowers can qualify for competitive rates by improving their credit and shopping around for the best terms. If interest rates fall, borrowers with good or excellent credit who took out loans when interest rates were highest should consider refinancing their personal loans.
