Have Personal Loan Rates Bottomed Out?

Personal loan rates have mostly come down over the past few years, but consumers should be alert – that trend may have started to reverse.

Personal loans can be a good choice for financing unusual expenditures or consolidating more expensive credit card debt. Interest rates on personal loans are still unusually attractive, but consumers should be aware that they may become less favorable in the months ahead. These rates may already have hit bottom.

Personal Loan Rates Remain Low – But on the Rise

Based on quarterly data from the Federal Reserve, the average interest rate on a 24-month personal loan stayed below 10 percent for all of last year, the first time that had happened in more than 40 years of history. Although they have since risen back above 10 percent, at 10.03 percent, their first quarter of 2016 level remained well below the historical average of 13.39 percent.

Those low rates mean a relatively cheap source of financing for consumers, but the one thing to be concerned about is the recent trend. While mortgage rates drifted lower in the early part of this year, personal loan rates headed in the opposite direction.

A Weakening Economy Could Put a Damper on Personal Loans

Why have interest rates on personal loans headed higher while mortgage rates are still falling? Part of the answer might be the recent weakness in the economy.

After reaching a healthy level of 3.9 percent in the second quarter of last year, the real annual growth rate of Gross Domestic Product has now fallen for three straight quarters. The current estimate is that the economy grew at an annual rate of just 0.8 percent in the first quarter of 2016. Coupled with recent weakness in employment growth, this raises serious concerns that the economic recovery is stalling.

Personal loans are more sensitive to signs of economic weakness than mortgages. With housing prices still rising, lenders can be somewhat reassured about writing loans backed by those houses. On the other hand, personal loans are often unsecured, meaning that repayment depends largely on the continued earning power of the borrower. If the economy is threatening to slip into recession, there is reason to be concerned about that continued earning power.

To help cover this risk, borrowers may charge higher interest rates on personal loans, which is what seems to be happening. A weaker economy may also make it more difficult to get approved for a personal loan.

Debt Consolidation Remains Attractive

Personal loans are generally cheaper than credit card debt, so one use for them can be to consolidate credit card balances into one less expensive personal loan. The attractiveness of this strategy depends on how much cheaper personal loans are than credit cards.

Historically, the difference between what people pay on credit card balances and the cost of a personal loan has been 2.10 percent. The bigger this spread, the more attractive this form of debt consolidation is. Last summer, that spread reached an all-time high of 4.13 percent. Since then, that spread has narrowed a bit, to 3.48 percent.

3.48 percent is still significantly higher than the historical average of 2.10 percent, meaning the spread between credit card and personal loan interest rates still represents an unusually good opportunity to save money. However, if you think of that spread as a window of opportunity, the narrowing of that spread means the window is starting to close.

Relative to their own history and relative to credit card rates, interest rates on personal loans remain quite low and therefore still a good deal. However, these rates are always sensitive to changes in the economy, and this may mean they have already gotten as attractive as they are going to get.

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