In order to slow down inflation, the Federal Reserve should raise its interest rates from March.
Increases in the federal funds rate tend to make borrowing more expensive for consumers, but not all types of financing are affected equally.
Although personal loans may see higher average interest rates, the cost of borrowing with a personal loan is still heavily influenced by factors within your control, including the amount and term of your loan, your credit score and your existing debts.
Fixed rate vs variable rate loans
Most personal loans are fixed rate loans, which means that the annual percentage rate, which includes interest and any fees, does not change for the life of the loan.
This distinction is important because, unlike variable-rate loans, such as home equity lines of credit, fixed-rate loans aren’t as dependent on market conditions, says Michael Shepard, senior vice president of direct lending at consumption at the US Bank.
“Floating rate loans tend to be very much in line with the federal funds rate,” he says. “With shorter-term fixed rate loans, that’s a factor, but it’s not really a one-to-one correlation.”
Harry Zhu, senior vice president and director of personal loans at Alliant Credit Union, believes personal loan rates will rise, especially if the Fed raises the federal funds rate multiple times this year. The magnitude of the rate increase is less clear, he says.
Is it the right time to take out a personal loan?
If you’re already planning to apply for a personal loan in the coming months, getting one now could save you a slightly higher interest rate.
Personal loan rates have been relatively low since the start of the pandemic, and even small increases can make a substantial difference in the amount of interest you ultimately pay.
For example, a personal loan of $15,000 repaid over five years at an interest rate of 10% costs $4,122 in interest. The same loan at 12% interest costs $5,020.
Given the rising rate environment, taking out a personal loan now makes sense, according to Zhu.
“If you have a need, I think it’s a good idea to lock in a relatively low rate,” he says.
However, borrowers who are unsure of getting a loan should not let impending rate hikes rush them into a decision they are not ready to make.
Dan Herron, a certified financial planner based in San Luis Obispo, Calif., urges caution when it comes to taking out personal loans, especially if there’s a risk of default.
“As an advisor, I want my clients to make sure they fully understand the ramifications of this loan and what happens if you don’t pay it back within a certain time frame,” he says.
Personal loans for rising credit card rates
Borrowers looking to consolidate their credit card debt – a common use of personal loans – may want to pay close attention to upcoming rate hikes since the credit card interest ratesa type of variable rate financing, will likely increase.
If you qualify for a lower rate on a debt consolidation loan than the rate you pay on your credit cards, you can save money on interest, lower your monthly payments, and potentially get out of debt faster.
While consolidating debt at a lower rate is generally a good idea, Herron says, make sure you’ve resolved all of the circumstances that led to the debt in the first place.
How to get the cheapest personal loan
Overall interest rate trends are just one of the factors that make up the rate you receive on a personal loan. Here’s how to maximize your chances of getting the cheapest loan possible.
Check your credit: Your credit score and credit history have a big impact on your personal loan rate. Build your credit before you apply for a loan, and look for any errors in your credit report that could lower your score.
Repay other debts: Lenders will assess your other debts when evaluating your loan application. If you can pay off your debts before applying, it may lower your rate.
Reduce the amount and duration of your loan: Larger loans may carry a higher interest rate because they represent more risk for the lender. And the longer the repayment term, the more interest you will pay. To cut costs, apply for the lowest loan amount that still covers your expenses and choose the shortest term with monthly payments you can afford.
Add a guarantee: Linking collateral like your vehicle or an investment account to your loan application helps secure the loan, which leads to a more competitive rate. However, if you default, the lender can seize the asset.
Add a candidate: Joint and co-signed loans can mean lower interest rates if the additional applicant has a higher credit score or income than you. This applicant will also be responsible for loan repayments.
Choose the right lender: Look for the most affordable personal loan you can find. Banks tend to offer the lowest rates on personal loans to borrowers with good and excellent credit (690 FICO or higher). Credit unions also offer affordable loans and generally consider borrowers with lower credit scores. Online lenders serve borrowers across the credit spectrum, but rates may be higher.
Pre-qualification with multiple lenders is one of the best ways to check potential rates without hurting your credit score, but not all lenders offer this feature.
The article What do rising interest rates mean for personal loans? originally appeared on NerdWallet.
