A personal loan is a great option to consolidate credit card debt, fund small home improvement projects, or even take a well-deserved vacation—as long as it is used wisely. Part of obtaining a personal loan wisely is understanding how the average personal loan interest rate works so you can shop around and compare different loan companies for the best rate available.
If you are considering taking out a personal loan for any reason, this article will explain how interest rates are determined to help you find your perfect loan. The average personal loan interest rate is generally determined by a combination of the going market rates for well-qualified borrowers and your own personal creditworthiness. After we discuss those two main factors in more detail, let’s take a look at how rates have changed over time to better understand how they might change again in the future.
How Are Personal Loan Interest Rates Determined?
As mentioned, the average personal loan interest rate is primarily determined based upon how the economy is doing in general and how creditworthy you are in particular. In a bad economy, even those with high credit scores should expect to pay a premium to borrow money.
In a good economy, those with high credit scores can borrow money with low interest personal loans, and those with average credit scores may not get one of the best personal loan rates, but they can certainly find competitive rates. In addition to creditworthiness, lenders may change the interest rate you are offered according to proprietary formulas, which often take into account your income, profession, and the length of time you have lived at your current residence.
Economy’s Market Interest Rates
Market interest rates are determined by the concept of supply and demand of credit, as well as how safe the market is judged to be by investors. This is, in turn, affected by a whole host of global events that affect the world’s economy, including trade and commerce, inflation, war, and the economies of individual countries.
Here in the United States, market interest rates are particularly affected by the Federal Reserve Board (the Fed), which periodically changes the rate at which banks borrow money. This has repercussions across the entire country’s economy, including stock markets and lending practices, such as making personal loans at various interest rates.
When the going market interest rates are low, personal loan interest rates will also be low. When investors and lenders believe that the economy is unstable, they will want to charge more interest to better protect their money.
In addition to how well the market is doing, which affects rates for all borrowers, lenders will look at your creditworthiness, which will affect the rates you are personally offered.
“Creditworthiness” is a valuation by lenders of how likely you are to repay money that you borrow. In other words, it is a way to anticipate the probability that you will default on your loan and the lender will lose their money. A great deal of creditworthiness depends upon your credit score, which is affected by your repayment history and the types and amounts of credit that you borrow.
The key to receiving low interest personal loans is to position yourself to have good creditworthiness in the eyes of a lender. This means keeping your credit score up and also showing a responsible repayment history.
Although you cannot control the market’s average personal loan interest rate, you can control whether you are personally offered the best personal loan rate, or the worst, that the market has to offer. Even a couple of late payments within the last 12-24 months can significantly drop your creditworthiness in the eyes of a potential lender.
Types of Personal Loans
Personal loans can be used for virtually anything, but they can be either secured or unsecured, and also be fixed rate or variable rate. Most personal loans are unsecured loans, which means they have no collateral that the lender can repossess or seize if the borrower defaults. Sometimes, a lender will only loan money to a particular borrower if they put up collateral, such as a vehicle that the borrower already owns. These types of personal loans are called secured personal loans.
The type of interest rate is the other way personal loans differ. A fixed interest rate never changes. The borrower will pay the same rate in the first month of the loan as they pay in the last month. Variable rates, however, are tied to a market index and they will rise or fall depending upon how the market is doing. Although some borrowers choose variable rates to save money early in the loan term, if they do not pay off the loan early and the market worsens then they end up paying more money over the life of the loan.
How Have Personal Loan Interest Rates Changed in the Past?
The interest rates offered on personal loans change frequently as market rates go up and down with the changing economy. The United States experienced a recession just under a decade ago, and personal loan interest rates skyrocketed around 2008-2009 as a result of the bad economy. Borrowers whose excellent credit scores once allowed them to get loans at low interest rates hovering around 5-6% could find themselves paying upwards of 15% or more. Luckily, interest rates on personal loans have improved drastically since then, and within the last five years it has again become possible to get low interest personal loans with excellent credit scores.
Over the last year, rates in all categories of lending have risen slightly. As the United States economy improves, The Federal Reserve Board increases the interest rate at which banks borrow, which has a trickle-down effect on individuals seeking private loans. If you are considering taking out a personal loan, now might be a good time to do so. Historically, interest rates are much better than they were in the past. Looking to the future, it is possible that rates will climb and make future borrowing more expensive.
Author: Jeff Gitlen
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