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What Will the Fed Hike Do To Personal Loans?

As the Fed decides whether or not to increase interest rates, we ruminate about what these changes might do to personal loan products.

Learn how the federal reserve rate hike may affect personal loans.

It's being referred to as a "liftoff," and that should have everyone worried.

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All signs point to December bringing the first federal funds rate increase in nine years. Let's look at the major players, why they're doing this now, and what it might mean for tomorrow's personal loans.

The Value of a Dollar

Banks borrow money from the Federal Reserve. The Fed is in charge of keeping inflation low. So when the economy is strong, the Federal Reserve makes it more expensive for banks to borrow money. (They do this by raising the federal fund rate, or the interest charged to banks for borrowing additional reserves.) This discourages banks from borrowing money, which decreases the amount of money available to everyone. Money is worth more and inflation is avoided.

Why Have the Rates Been So Low?

For the last several years, the federal funds rate has been around zero-percent (compare that to the 1980s when it was upwards of 20-percent). The rates have been low in response to the financial crisis of 2007 to 2009, when the housing market and banking sectors crashed. To keep the economy afloat and avoid a great depression, the Federal Reserve drastically lowered the federal funds rate to encourage banks to borrow more money, which in turn made it easier for consumers to borrow money.

Apparently it worked and the economy is doing better. The private business sector is hiring at unprecedented rates. Unemployment has shrunk. To the Federal Reserve, this means it’s time to take a proactive step against inflation and raise the federal funds rate.

Plenty of Critics

Not everyone is a fan of the rate increase. Some argue that there isn’t any risk of inflation, so the rate increase is unnecessary. Others argue that the rate hike could slow down economic recovery and make it more difficult for workers to ask for higher wages.

Even the top experts are divided, with some saying the Fed should wait and others saying they should raise rates, but do so very carefully.

Fed Promises Small Increase

According to Janet Yellen, the Chair of the Board of Governors of the Federal Reserve System, rate rises will be gradual. At a meeting in September, the Federal Reserve outlined the pace at which the rate would increase and where they predicted the rates to stop. These figures show the interest only rising a little over one-percent through 2016 and leveling out at just over three-percent in 2018.

Predictions for the Future

Still, a rate increase will be felt by anyone borrowing money. Remember, by increasing the federal funds rate, the Federal Reserve is making money more expensive for everyone. That’s good for people who already have money – since their cash will be worth more and their savings account interest rates should go up, too – but not so great for anyone who needs to borrow money.

Interest rates on loans will likely rise.

This should prove true for credit cards and mortgages, as well as for personal loans. But nobody really knows. It’s been nearly a decade since the last U.S. rate rise. A lot has changed since then and it’s not easy to predict what will happen this time around. Maybe the rate increase will lead to higher interest on mortgages. Maybe not.

In a recent Reuters article, Dick Lepre, who works for RPM Mortgage as a senior loan officer, said that mortgage rates and the federal funds rate are not directly tied to each other. Responding to the question of whether people should refinance or not, he said, “At this point, nobody knows.”

With all this uncertainty, an honest financial advisor isn’t going to tell you to refinance your mortgage. We won’t tell you to get a personal loan now instead of later.

One thing is clear, though: life is about to get harder for borrowers. Let’s not forget that the CFPB is currently doing everything they can to try to outlaw short-term loans. Once that financial product is gone, it’s going to be very hard for those with no credit to get credit. Many might be persuaded to take out a personal loan because a short-term loan is no longer an option. This increased demand combined with the higher federal fund rate might lead to higher interest rates for personal loans.

We’ll know more on Dec. 16. That’s when the Federal Open Market Committee is expected to set the new target rate. If they do decide to raise rates, it will likely be a small adjustment at least at first. We’ll have to wait a few years to see if the Fed decides to follow its own projections or not.

You don’t have to be a kite to see which way the wind is blowing. In the coming years, those with money will be better off than those without. We suggest doing what you can to save up now so you’re in a better position for the future.