Personal loan debt in the U.S. reached $210 billion in the third quarter of 2022, and the number of consumers with personal loans reached a record high. With rising inflation and rate hikes by the Federal Reserve, interest rates for lending products have increased - and they're about to get even higher. According to a Bankrate survey, economists believe the Fed will raise interest rates above the 5 percent-mark in 2023.
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While most personal loans are fixed-rate loans, meaning that the interest rate does not change over the life of the loan, borrowers with variable-rate personal loans are directly impacted by the Federal Reserve's rate hikes. In addition, Federal rate hikes and inflation do impact interest rates for new fixed rate personal loan borrowers, although indirectly.
As economic conditions worsen and more Americans find themselves taking on personal loan debt, it is important for consumers to understand how inflation and Federal rate hikes affect their loans. Before taking out a personal loan, calculate how much you will be paying in interest to avoid deferring on a loan or taking on unnecessary debt.
Interest rates are the amount of interest due per period on a loan. They are typically expressed as an annual percentage of the loan amount due.
Interest rates change based on the market demand for credit-the more demand there is for credit products, the higher interest rates are likely to be. If demand for credit products goes down, interest rates will also go down. Decisions from the Federal Reserve also influence interest rates for most credit products. When the federal rate goes up, interest rates tend to rise for most loan products.
The Federal Reserve raised the federal rate seven times last year - a trend that's likely to continue throughout 2023 as economists predict rates will peak at above 5 percent by the end of the year. The purpose of these rate hikes is to fight inflation.
That said, it does seem that the Fed's efforts to combat inflation has had a positive impact on the housing market. As mortgage rates are rising, housing prices are beginning to ease. According to Federal Reserve Chairman Jerome Powell, "the deceleration in housing prices that we're seeing should help bring prices more closely in line with rents and other housing market fundamentals - and that's a good thing."
Interest rates impact more than the credit and lending sphere: they affect stocks, bonds, consumer and business spending and inflation. As interest rates continue to rise for most credit products, Americans are feeling the weight of those extra costs. However, with inflation at a 40 year high, it seems that raising rates is the only way to combat rising prices.
The start of the pandemic saw a severe drop in average interest rates. That drop is offset by the 1.7 percent jump the U.S. saw in 2022.
When it comes to a state-by-state look at personal loan interest rates, there is an almost 4 percent difference between Rhode Island, which has the highest rate, and Florida, which has the lowest.
The interest rates you qualify for have a lot to do with your credit history and credit score. Your credit score is the primary factor that most lenders consider when approving or denying your loan application. Borrowers with excellent credit are far more likely to get a lender's lowest rates than borrowers with fair or bad credit.
Source: Bankrate
Since borrowers with good to excellent credit are more likely to qualify for the best rates, it makes sense that the Baby Boomer generation tends to take out more loans than other generations. Boomers have the highest overall personal loan balance of all generations, with an average balance of $20,370.
The interest rate you qualify for depends on your credit score and financial background, but it also depends on the type of lender you choose.
Banks tend to have the highest interest rates and strictest eligibility requirements because these institutions are so highly regulated. Credit unions typically have slightly lower rates since they require membership to apply for loan products. However, online lenders typically have the lowest rates of all, as well as the most lenient eligibility requirements.
Social bias and racism also play a role in who gets what rates. Research suggests that high-income Black homeowners receive higher mortgage interest rates than low-income White homeowners.
Evidence suggests that Black and Hispanic consumers are more likely to be victims of predatory payday lenders. These disparities are likely due to systemic racism in lending and differing socioeconomic circumstances perpetuated by systemic racism.
In its fight to lower inflation, the Federal Reserve has been aggressively raising interest rates. Ideally, raising interest rates will bring up borrowing costs, causing consumers to spend less money. This will lower the demand for goods and services and cause inflation to fall.
Lowering inflation is the Federal Reserve's top priority, as inflation is the worst that it has been in 40 years, and consumers feel the weight of that. A recent Bankrate survey found that 55 percent of people say that income has not kept up with the increases in household expenses due to inflation.
Despite these efforts by the Federal Reserve, inflation has continued to be a looming presence, and many experts expect it will get worse before it gets better. Fifty-six percent of Americans are experiencing financial hardship due to inflation.
55 percent of working Americans say that income has not kept up with the increases in household expenses due to inflation.
- Bankrate Surveybankrate.com
Consumers are cutting back on spending, driving less and canceling their vacations to cover costs. While lower-income Americans have been feeling the pain of rising prices since last year, middle- and upper-class households are also feeling that pressure. With rising interest rates, it seems that gas and housing prices are beginning to ease a bit.
But despite this, many experts believe that inflation has not yet reached its peak. Not only that, but economists now say there's a 64 percent chance that the U.S. economy will enter a recession in 2023, as a result of sky-high inflation coupled with higher borrowing costs. This means that consumers will likely continue to face financial woes for the remainder of the year.
While U.S. households are keenly aware of how much inflation affects every day costs, certain areas saw a higher jump than others.
Consumers can find and apply for both fixed-rate and variable-rate personal loans. However, fixed-rate personal loans are far more common.
Fixed-rate personal loans have the same interest rate over the life of the loan, meaning that you do not have to worry about your rate going up once you are locked into the loan. Variable-rate personal loans have rates that can go up and down depending on market conditions, meaning that the recent federal rate hikes directly impact the interest rates on these loans.
Fixed-rate personal loans are generally preferred because they are more predictable. While new fixed-rate loan borrowers are likely to see higher interest rates than past borrowers, there is no risk of that rate increasing once you're locked in, making fixed-rate loans a much safer option.
Borrowers with a variable-rate loan are likely to see higher monthly payments due to rising interest rates. For borrowers on a tight budget, rising rates could mean the difference between paying off the loan and going into delinquency.
If you got a variable-rate personal loan when interest rates were low and you're worried about rising costs, there are some things you can do to avoid paying a fortune in interest.
While rising interest rates certainly cause consumer anxiety, America's current inflation problem is the top priority. Americans are struggling to cover basic necessities and housing, and the Federal Reserve is raising rates to ease that financial burden.
While inflation is likely to worsen before it improves, there have been signs that raising interest rates is beginning to improve housing and gas prices. For consumers struggling with variable-rate credit products, transferring that debt to a fixed-rate credit product could ease that financial strain.
There is no denying that rising interest rates and inflation are both causing financial hardship for consumers, but there are things that individuals can do to stay afloat. If you are having trouble managing your finances during the current uncertainty, look into preparing your finances for a recession.