Lower Interest Rates, More Affordable Loans
Personal loans are the most prevalent kind of consumer borrowing in the United States, and they’re only getting started. That’s because, by the end of July, the Federal Reserve will drop its benchmark interest rate for the first time in a decade. According to CME Group’s FedWatch tool, markets were pricing in a 78.6 percent chance of a quarter-point rate drop, or 0.25 percent, in July as of this writing. A half-point rate drop has a 21.4 percent chance of happening.
When the Federal Reserve lowers interest rates, personal loans become more affordable.
The Federal Reserve Bank of St. Louis estimates that the average interest rate on 24-month unsecured personal loans provided by commercial banks was 10.63 percent in May 2019. This was a slight increase from the all-time low of 9.45 percent in November 2016, but it was still well below the 12 percent-plus threshold that was a constant feature of personal loans from 1972 to 2002, when records began. Personal loan rates have been below 12% since 2006-7, with the exception of an 18-month period in 2006-7.
It should be emphasized that the aforementioned data came from commercial banks and did not include FinTech companies, which are now the most common form of personal loan lender. In the fourth quarter of 2018, Experian, one of the three credit bureaus, conducted its own study and concluded that the average personal loan rate was 9.37 percent, somewhat lower than the Federal Reserve Bank of St. Louis’ estimate.
In any case, personal loan rates have always been tightly linked to the federal funds rate during the last half-century, and for good reason: when the Fed lowers interest rates, lenders follow suit. Borrowing rates decreased steadily in the years following the 2008 financial crisis, when the Federal Reserve cut its target rate to near zero, and only started to rise in the last two and a half years, after the Fed began raising its rate. Personal loan rates are likely to fall in lockstep with the Fed’s rate cuts, which are expected to happen at least three times by early 2020.
The following is the rationale for the link: Most personal loan lenders, like mortgage lenders and credit card companies, base their rates on the prime rate, which is the average of what ten major American banks charge low-risk corporate customers. On a daily basis, each bank sets its own prime rate, but the average is consistently 3 percentage points higher than the target funds rate. The target funds rate was 2.50 percent in mid-July 2019, while prime was 5.50 percent.
Personal loans are already the most popular type of borrowing
Personal loans have easily outpaced mortgages, credit cards, auto loans, and other types of consumer borrowing in the last five years, with little signs of slowing even as interest rates rose between 2017 and the first half of 2019. With interest rates on the decline, personal loans are likely to become even more popular.
In its Q1 2019 Industry Insights Report, TransUnion, one of the main three credit bureaus, revealed that personal loan balances in the United States increased 19.2 percent year over year to a record $143 billion. Since 2015, when total balances were $72 billion, total balances have nearly doubled, with growth across all risk classes, from borrowers with sub-620 credit to borrowers with near-perfect 781-820 credit. An all-time high of 19.3 million Americans have an unsecured personal loan as of March 2019.
Two particularly notable developments are highlighted in the TransUnion report. In Q1 2019, fintech lenders like SoFi and Marcus raised their proportion of personal loan balances to 38 percent, up from 6 percent in 2014. Banks and credit unions have lost market share as a result.
Furthermore, personal loans have evolved from being primarily the domain of high-risk (low-credit or sub-prime and prime) borrowers to now being the domain of all borrowers, including low-risk (high-credit or above-prime) borrowers. In the first quarter of 2019, personal loan originations among above-prime borrowers increased by 23% year over year. In the 12 months leading up to Q1 2019, above-prime borrowers accounted for 16 percent of new personal loans, up from 12 percent just five years before. Other borrowers rose at a slower rate in the past year, with originations involving prime borrowers (621-680) increasing 10% and sub-prime borrowers increasing 6%.
The average size of new personal loans has grown across the board, with above-prime borrowers once again leading the way. New loan amounts for above-prime borrowers increased by 68 percent to $13,129 between Q4 2018 and Q4 2019. Sub-prime loans increased by 40% to $2,032 during the same time period.
As interest rates fall, here’s how to get the best unsecured personal loan possible.
Personal loan rates don’t stay the same for long, as this article reveals. It’s difficult to predict how much a personal loan will cost in six months or a year, but data shows it will be less than it is now.
Here are some pointers on how to take advantage of low personal loan rates.
Take out a little loan right now.
Lenders are eager to make 5-figure offers, but you don’t have to take them. If you want to spend your personal loan funds gradually, consider getting a small loan now and applying for a larger loan in a few months when interest rates are lower. If you have bad credit, taking out a small loan can help you improve your score and improve your borrower profile. That’s because a person’s payment history is the most important criteria considered by credit bureaus when establishing their credit score. It’s important to note that if you have many credit cards, you should pay them off first before applying. This is due to the fact that using too much credit can harm your credit score.
Improve your credit score. When it comes to improving your credit score, a little forethought now can pay dividends a few months later. Making on-time monthly payments on open credit accounts (such as mortgages or credit cards) or paying off outstanding balances can have a big impact quickly. Requesting a credit statement from each of the credit agencies is something else we recommend. Every American has the right to a free credit report once every 12 months. If you see any inaccuracies, report them to the appropriate credit bureau so that they can be removed from the record. The better your credit score, the cheaper the interest rates you may be eligible for. This is significant since a 1- or 2-point reduction in APR can result in hundreds or even thousands of dollars in interest savings over the life of your personal loan.
Take a look around.
The golden guideline for every lending product is to compare. The easiest approach to see what rates are available right now and what rates lenders are prepared to provide you is to do a comparison shop with 3-5 lenders.
