You might want to pay extra attention if you have a variable-rate loan.
How does the fed rate affect personal loans?
A federal rate change directly affects the interest rates banks charge on all new personal loans and some current personal loans. With current loans, how it affects you depends on what type of interest rate you have.
How does the fed rate affect variable-rate loans?
Changes in the fed rate affect both new and current variable-rate loans. With new loans, an increase or decrease means you’ll start off paying either higher or lower rates than you would have before.
But since variable-rate loans fluctuate based on the lending market, a change in the federal rate will also cause interest rates on your current loan to go up or down.
How does the fed rate affect fixed-rate loans?
Changes in the federal rate only affect new fixed-rate loans. An increase in the fed rate typically means banks and other lenders will increase their fixed rates. Similarly, a decrease in the fed rate generally sees a decrease in interest rates banks charge.
Since fixed rates stay the same over the life of the loan, any changes to the fed rate after you sign your loan documents have no affect on your current loan.
How variable and fixed rates work on personal loans
What’s the fed rate?
The fed rate, also known as the federal funds rate, is the benchmark rate the Federal Reserve uses to lend banks money. To understand the fed rate, you first need to understand how the Federal Reserve works.
The Federal Reserve is the US central bank. It’s responsible for keeping the economy stable by controlling inflation and encouraging employment. One of the ways it influences the economy is through the rates it charges when it lends to banks.
As a benchmark rate, the fed rate is the lowest rate it charges when it makes loans to banks. When the Federal Reserve lowers rates, banks can afford to charge lower rates. When the Federal Reserve increases rates, banks also increase interest rates.
Why does the fed rate change?
The Federal Reserve changes interest rates mainly to maintain a stable economy. So if the economy is doing well, Federal Reserve rates typically increase to prevent inflation. When the economy is doing poorly, the Federal Reserve lowers rates.
The Federal Open Market Committee meets eight times a year to discuss whether or not the Federal Reserve should raise rates.
What’s the current fed rate?
The current fed benchmark rate is 2.5% as of February 2019. But the Federal Reserve has indicated it might raise the fed rate to 3% later this year.
What happens when the Federal Reserve changes rates?
When the Federal Reserve changes its benchmark interest rate, interest rates on new and variable-rate financial products change. That’s because banks must charge a higher interest rate to make a profit, so when the Federal Reserve changes its interest rates, so do banks.
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How else can a fed rate increase impact me?
The fed rate doesn’t just have an impact on personal loans — it affects most financial products that come with an interest rate or yield rate. Here’s how:
- Credit cards. Credit cards typically come with variable rates, so any change to the fed rate should impact the rate on both new and current credit cards.
- Mortgages. Variable-rate mortgages and new mortgages can see an increase or decrease in interest rates along with the fed rate. Current fixed-rate mortgages are unaffected.
- Car loans. Variable-rate and new auto loans also go up or down with the fed rate, but current fixed-rate car loans stay even.
- Student loans. Congress sets federal student loan rates, so they’re usually not directly affected by the fed rate. However, variable-rate and new fixed-rate private student loans are impacted by the fed rate.
- Savings accounts. The annual percentage yield on high-rate savings accounts may increase as the fed rate increases — and vice versa.
Bottom line
If you already have a personal loan, the fed rate might not have any impact on how much you pay in interest. However, if you’re thinking of getting a new loan or have a variable-rate loan, trends in the fed rate could be worth paying attention to.
Find out more about how it all works by reading our guide to personal loans.
