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If you’re a borrower who’s thinking about getting a personal loan sometime in the near future, watching interest rates fluctuate and thinking about how Fed rate changes impact personal loans and savings can be pretty nerve-wracking.
That’s because even if your personal financial bonafides are in a good place, if the Federal Reserve raises or lowers its target rate — known as the federal funds rate — it could end up affecting how much interest you’ll pay on a new loan.
Though the Fed doesn’t directly set personal loan rates, its monetary policies can be an important factor in determining the rates lenders offer. Read on for a look at how Fed rate changes impact loans and cause ripple effects that influence your finances.
Key Points
• The Federal Reserve doesn’t determine the interest rates lenders set on consumer savings accounts or loans. But its benchmark federal funds rate can indirectly affect those rates.
• If the fed funds rate increases while you’re preparing to take out a new personal loan, you may see interest rates go up. If the fed funds rate decreases, rates may go down.
• If you already have a fixed-rate personal loan, a fed funds rate change won’t affect your interest rate or payments.
• Improving your personal creditworthiness could help you score a lower interest rate on a new personal loan.
What Is the Federal Funds Rate?
The federal funds rate is the rate commercial banks use when they borrow and lend their excess reserves to each other overnight. But the fed rate can impact your savings, too. It can have an indirect effect on the interest rate consumers earn on certificates of deposit (CDs), savings accounts, and some other bank accounts. And it also can influence the rates banks offer on consumer loans — including personal loan rates.
When the fed funds rate increases, borrowing typically becomes more expensive. When the fed funds rate is cut, borrowing costs generally fall.
Members of the Federal Open Market Committee (FOMC) use the fed funds rate (which is actually a target range rather than one specific number) to help keep the U.S. economy healthy. If inflation is high, for example, the FOMC may decide to raise the fed funds rate in an effort to cool down borrowing and spending. If economic conditions are weakening, on the other hand, the FOMC may choose to cut the benchmark rate to stimulate borrowing and investment.
The FOMC meets eight times a year to decide whether to raise or lower this target rate, or to keep it where it is.
Recommended: History of the Federal Reserve
How the Fed Affects Personal Loan Interest Rates
When someone applies for a credit card or loan, the interest rate the customer is offered can vary significantly based on their credit score, income, the amount they borrow, and other factors. But lenders may also use the prime interest rate — the rate they charge their most creditworthy customers — as a basis to determine what to charge other borrowers, including those with personal loans.
The prime rate is not a Federal Reserve product. But when the FOMC raises or lowers its fed funds rate, it usually affects where banks set the prime interest rate.
Banks generally calculate the prime rate by adding 3 percentage points to the current federal funds rate. How do Fed rate changes impact personal loans and savings? For example, if the fed funds target rate is 3%, the prime rate would be 6%.
Here’s more on how Fed rate changes impact loans:
How Rate Changes Impact New Borrowers
You might not see a change in personal loan interest rates immediately after the Fed lowers or raises its target rate. But eventually, you may notice a cut or hike trickling down to the rates offered by various lenders.
• If there’s a hike in the fed funds rate, for example, some lenders may opt to minimize the impact to their own borrowing costs by raising the interest rates on new loans.
• If there’s a cut to the fed funds rate, lenders may decide to cut their interest rates on new loans to reflect the decrease in their own borrowing costs.
Again, you might not see a change right away. Personal loans aren’t directly tied to the prime rate the way variable-rate loans or credit cards are, and lenders may have more discretion regarding their pricing. Still, if you’re out there shopping for a personal loan, you may want to keep an eye on fed rate changes and consider how they could affect your costs.
Recommended: Average Personal Loan Interest Rates
How Rate Changes Impact Existing Loans
Most personal loans come with a fixed interest rate — which means the rate you agree to when you open the loan will stay the same until you pay it off. So, if the FOMC raises the fed funds rate and you already have a personal loan, you don’t have to worry about the hike increasing your monthly payments.
If the FOMC were to cut the fed funds rate, however, that move also wouldn’t have any effect on an existing fixed-rate loan’s payments. Even if your lender lowers rates for new borrowers, the interest rate you originally agreed to would remain locked in. In order to take advantage of the lender’s new lower rate, you would have to refinance to a new personal loan.
Are Personal Loan Rates Expected to Drop?
It can be difficult to predict when or if the FOMC might cut the fed funds rate, or if the interest rates consumers are offered will drop.
The Federal Reserve’s decisions about monetary policy are based on what is commonly known as its “dual mandate” to pursue both maximum employment and price stability. Toward that end, the FOMC considers several factors when determining how to manage the fed funds rate, including the inflation rate, the labor market, and overall economic growth. And the FOMC has 12 members — each with his or her own “hawkish” or “dovish” thoughts on how best to guide the economy.
What you as a borrower can have some control over, however, is what you personally bring to the table in terms of creditworthiness. Whether you decide to wait for a rate drop or to forge ahead, preparation can be key to avoiding a high interest rate on a personal loan.
How to Get a Better Personal Loan Rate Despite High Rates
Knowledge really can be a super power when it comes to getting the best available loan rate. Consider taking these steps as you prepare to apply for a personal loan:
• Get your credit in the best shape possible. Check out your credit score and credit reports so you know what lenders will see. Correct any mistakes, and work to improve areas where you may appear financially risky. “Late payments can have a large effect on your credit score for a long period of time. Setting up autopay is one way to make sure payments are made regularly and on time,” says Brian Walsh, CFP® and Head of Advice & Planning at SoFi. (Also keep credit card balances as low as possible, and try not to apply for another credit card or loan in the months before you apply for a personal loan.)
• Do some comparison shopping. Hop online to check out which lenders are offering the most competitive rates. See if you can prequalify with a soft credit check that won’t bump up your credit score.
• Look beyond the interest rate. Consider other loan details, including low or no fees, customer service, and hardship policies.
• Be flexible. Would you be able to manage a higher monthly payment if it meant getting a lower interest rate? Compare different loan lengths and payment amounts to find your best fit.
• Consider a co-signer. If you know someone with good credit who is willing to co-sign your loan, it may help you qualify for a lower rate. (Especially if you don’t have much of a credit history.) Keep in mind, though, that the lender will hold you both responsible for repaying the loan.
The Takeaway
Understanding the factors that can influence your personal loan interest rate can help you get the best possible rate quote. The federal funds rate can have an indirect effect on the interest rates banks offer — including the rates on personal loans. So stay on top of news from the Fed if you’re considering applying for a loan.
But you can also get control over your personal loan costs by taking good care of your credit, shopping online for the best lender and rate, and avoiding unnecessary fees.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.
FAQ
How is the federal funds rate determined?
The Federal Open Market Committee (FOMC) meets roughly every six weeks to determine whether the federal funds rate should be increased, cut, or stay the same. Committee members base their decisions on several factors, including the inflation rate, the labor market, and overall economic growth.
Do Fed rate cuts automatically lower my personal loan rate?
If you already have a personal loan with a fixed interest rate, a cut to the fed funds rate won’t affect your rate at all. If you’re still out there looking for a loan and wondering are personal loan rates expected to drop, consider that a rate cut might eventually lower the interest rates lenders are offering, but not always, and it could take a while to see a rate drop.
How do Fed rate changes affect savings account rates?
Fed rate changes can influence the prime rate, which can impact the interest rate consumers earn on certificates of deposit (CDs), savings accounts, and other types of bank accounts. Savings account interest rates tend to rise if the Fed raises rates and fall if the Fed lowers rates.
How long does it take for personal loan rates to respond to Fed changes?
Because the connection between the fed funds rate and personal loan rates is indirect, it can be difficult to predict when, or if, a Fed cut or hike will trickle down and affect lending rates.
Should I wait for rates to drop before taking out a personal loan?
You may want to keep an eye on market changes if you’re thinking about applying for a personal loan. But if you need a personal loan and you’re on a tight timeline, don’t focus on how high interest rates affect personal loan rates. Instead, try to work on factors over which you have some control, like raising your credit score and lowering your debt levels.
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