What rising personal loan rates mean for borrowers

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Personal loan rates from banks, credit unions and online lenders are on the rise after repeated Federal Reserve interest rate hikes this year, the last of which came last week.

The funding rate for banks’ 24-month personal loans fell from 8.73% in May to 10.16% in August, according to the latest data from the Federal Reserve Bank of St. Louis. The average annual percentage rate on 36-month loans from credit unions rose from 8.84% in June to 9.15% in September, according to the National Credit Union Administration.

Most personal loans have fixed rates, so if you already have a personal loan, your monthly payments won’t change. But potential borrowers could face higher monthly payments and may qualify for lower loan amounts compared to earlier this year.

Why are personal loan rates increasing?

Until recently, lenders have kept rates relatively low for several reasons.

Personal loan rates are somewhat tied to supply and demand, which is why they don’t track Federal funds rate as closely as other financial products like mortgages, says Werner Loots, executive vice president of consumer direct lending at US Bank.

And demand for personal loans has been high this year, Loots says, in part because personal loans are an attractive fixed-rate financing option that can be used for almost anything at a time when prices are high for almost everything.

Strong demand fueled competition among lenders, which kept personal loan rates low even as the Fed rate climbed, said Salman Chand, vice president of consumer loans at TransUnion.

But the Fed and the state of the economy could put pressure on lenders. A Fed rate hike, coupled with fears of an economic slowdown, could cause lenders to tighten their borrowing criteria and make fewer loans overall, leading to higher personal loan rates.

“If you’re not making as many loans and your cost of borrowing is going up, you have no incentive to keep rates low and try to attract as many consumers,” Chand says.

Is it harder to qualify for a personal loan?

Lenders could tighten underwriting criteria if they believe a recession is likely, Chand says.

Since unsecured personal loans do not require collateral, lenders rely on applicants’ credit profiles and finances to determine if a borrower is likely to repay the loan.

Personal loan delinquency rates — the percentage of all loans that are in arrears — have risen steadily this year and, in the third quarter, surpassed pre-pandemic levels, according to a report from the TransUnion’s credit industry.

Rising delinquency rates are a signal lenders use to decide whether or not to tighten approval standards, Chand says. If they do, consumers with good or bad credit scores (typically below 689) may find it difficult to qualify.

Growing unemployment could also trigger tougher borrowing standards as lenders fear giving loans to consumers who could be laid off, says Katherine Fox, certified financial planner and founder of Portland, Oregon-based Sunnybranch Wealth.

So far this year, unemployment has remained consistently low.

Even if lenders aren’t tightening their approval criteria, higher rates mean you may qualify for a lower loan amount than you would have gotten earlier this year, Fox says.

When deciding whether or not to approve your application, lenders look at how much of your monthly income goes to paying off debt, also called your debt-to-income ratio. They include the potential personal loan payment in this calculation.

For example, if a lender only accepts borrowers with a DTI of less than 40%, that would mean that all of your current debt payments, plus your new personal loan payment, could cost no more than 40% of your income. monthly.

Higher personal loan rates mean higher monthly payments, so a lender may approve you for a smaller loan to avoid overextending you, she says.

Is it the right time to take out a personal loan?

Your rate today may not be as low as it would have been a few months ago, Fox says, but it could go up.

If you plan to apply for a personal loan in the coming months, it’s a good idea to shop around and lock in a rate before it rises again, she says.

For non-emergency expenses like home renovations and vacations, getting the best APR means waiting. If rates go down, it probably won’t be for at least a few months, Fox says.

“It’s either about moving quickly or being completely flexible because that rate cut could come sooner than any of us think or it could take longer,” she said.

Rates are up on other financial products like home equity loans and credit cards, but it’s always a good idea to compare other options to see where you get the lowest rate, says Ian Bloom, CFP and owner of Open World Financial Life Planning in Raleigh, North Carolina.

Those with enough equity in their home can get a better equity financing rate than they would with a personal loan, and consumers with strong credit can qualify for a 0% credit card. APR, he said. With a zero rate credit card, pay off the balance during the promotional period to avoid a high rate.

Tips for lowering your personal loan rate

Rising APRs mean you may need to take more steps to get a low rate. Here are some tips to improve your chances of getting an affordable loan.

Pre-qualified. Pre-qualification allows you to check the amount, rate and repayment term of your personal loan without worrying about your credit. Online lenders, banks, and credit unions offer pre-qualification — and even if your bank doesn’t, you can present them with a pre-qualified offer and ask if they’ll beat that offer.

Consider a co-applicant or collateral. If your credit or DTI could prevent you from getting a low rate, consider a co-signed, joint or secured loan. With a co-signed or joint loan, you add someone with better credit and higher income to your application, and they promise to repay the loan if you don’t. With a secured loan, you provide collateral in exchange for a lower rate or a larger loan, but the lender can take the property if you miss payments.

Build your credit and reduce your debt. The best way to get a good rate is to have good or excellent credit (a score of 690 or higher) and a low DTI. If you’re not getting the deals you want through pre-qualification, it’s time to consider other borrowing options and work on repay the debtwhich can increase your credit and lower your DTI.

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