In an economy nearly always impacted by inflation, many are curious about how inflation affects personal loans. There exists a certain relationship between inflation and interest rates, as the Federal Reserve adjusts the benchmark interest rate to control inflation.

This implies that if the inflation rate climbs above the optimal level, the Federal Reserve will increase the benchmark interest rate, which in turn, gets reflected in the interest rates for consumer savings and loans.

By the start of 2023, the average interest rate for personal loans had risen to 11.58%. While this might seem negligible, an additional 1% can significantly impact your personal loan.

What Should You Know About Personal Loan APR?

For those new to personal finance or first-time borrowers, the terminology around loan products can be perplexing, with personal loan APR being among the most common terms encountered.

APR stands for Annual Percentage Rate. Essentially, it represents the cost charged by lenders for borrowing. Similar to how you earn interest on your savings account, the APR on your loan relates to the fees the bank charges for this service.

As the ‘A’ in APR signifies annual, this percentage is for the entire year. However, while the interest rate remains constant, the outstanding balance decreases with each monthly payment. Consequently, over time, the dollar amount of interest paid diminishes.

Example of Personal Loan APR

For instance, borrowing $10,000atanannualinterestrateof10$1,000 in interest annually.

However, if you’re making monthly repayments of 500,𝑖𝑛𝑡ℎ𝑒𝑓𝑖𝑟𝑠𝑡𝑚𝑜𝑛𝑡ℎ,𝑦𝑜𝑢′𝑙𝑙𝑝𝑎𝑦1/12𝑜𝑓𝑡ℎ𝑒500,inthefirstmonth,you′llpay1/12ofthe1,000 interest, with the remaining payment reducing the loan balance. Thus, the next month, you’d pay interest on a reduced balance of $9,583, leading to lower interest payments as your loan balance continues to decrease.

You won’t need to delve deeply into calculations, as your loan agreement will detail how much interest you’ll pay over the loan term at the indicated APR.

How is Your Personal Loan APR Determined?

Your personal loan APR is calculated based on your specific application and financial situation. Financial institutions consider various factors to determine your rate, including:

• Benchmark Rates: Banks and financial institutions pay close attention to changes in the Federal Reserve’s benchmark rates. As these rates increase, so do the banks’ rates.
• Your Credit: Lenders decide on your personal loan interest rate based on your risk profile. Good or excellent credit almost guarantees you’re seen as financially responsible and likely to repay the loan.
• Your Income: While your credit score and report play a role, lenders need assurance you have sufficient income for the new loan. Most lenders require a minimum annual income of $20,000.
• Loan Amount: Generally, larger loan amounts secure better interest rates. Although smaller loans pose less risk, they often involve more administrative work for the bank.
• Term Length: Typically, longer-term loans can secure lower interest rates. This is because banks can rely on a long-term relationship, leading to more potential profit.
• Security: While most personal loans are unsecured, some institutions offer secured personal loans, requiring some form of collateral.

What Should I Expect My Rate to Be?

As previously discussed, one key factor influencing your rate is your credit score. While it’s challenging to predict your exact rate, knowing some averages can be helpful:

• Excellent Credit: With a score of 720 or higher, you can expect an average personal loan rate between 9% to 13%.
• Good Credit: Scores above 680 may yield an average APR of 17.8%.
• Fair Credit: Scores between 580 and 680 categorize as fair credit, with average rates around 22%.
• Poor Credit: Scores below 580 are seen as poor, potentially leading to APRs exceeding 30% from specialized lenders.

Interest Rate vs. APR on Personal Loans

A potentially confusing aspect of personal loans is the presence of two percentages: the interest rate and the APR. While these are often the same, there’s a crucial difference affecting your decision:

• Interest Rate: This is the basic cost of borrowing money, expressed as a percentage of each payment.
• APR: This percentage represents the annual cost of the loan, incorporating any fees in addition to the interest rate.

Comparing Personal Loan Rates

When shopping for loans, consider the following to make accurate comparisons:

• APR: Look at the annual percentage rate to see which loan offers a lower rate.
• Fees: Account for any loan processing fees or other charges that might apply.
• Prepayment Penalties: These can affect your flexibility to pay off the loan early or refinance in the future.
• Like-for-Like Comparisons: Ensure you’re comparing similar loan amounts and terms.

Lowering Your Personal Loan APR

If you’re struggling to secure a favorable APR, consider improving your credit, evaluating your debt-to-income ratio, exploring secured loans, or using a co-signer. Alternatively, look into different loan products that might offer better rates for your financial situation.