During the second quarter of this year, the average interest rate on personal loans reached one of the lowest levels on record. That makes this an especially attractive time to get a personal loan, and a potential threat from inflation means that consumers might be well advised not to delay in acting on this opportunity.
Lowest Personal Loan Rates on Record
According to Federal Reserve data going back to 1998, the 9.65 percent average rate on 24-month personal loans posted during the second quarter of 2016 was the second lowest on record, just slightly higher than the level of 9.57 percent reached in the second quarter of 2014.
To put the recent rate of 9.65 in perspective, over time interest rates on personal loans have ranged from that low of 9.57 percent to a high of 14.1 percent late in the year 2000. Clearly, current rates are much closer to the low end of the range, and well below the long-term average of 11.54 percent.
That's good news for consumers, but the one caveat is that these rates have been facilitated largely by unusually low inflation – and inflation is showing signs of making a resurgence.
Why Low Rates May Not Last
Here are four reasons to be concerned about the impact inflation might have on personal loan rates:
- While still low, inflation has been rising lately. A year-over-year inflation rate of 1.0 percent does not sound like much, but consider where it is coming from. At the end of June 2015, year-over-year inflation was just 0.1 percent. Not only is inflation over the most recent 12-months higher, but it is accelerating, with a 0.8 percent rise in the second quarter of 2016 alone. That would project to a 3.2 percent annual inflation rate. So, price increases have gone from virtually stagnant to having a modest amount of positive momentum.
- Outside of energy prices, inflation is stronger than it looks. Other than energy, many components of inflation are advancing more rapidly than that 1.0 percent overall rate. If you back out energy prices, the Consumer Price Index (CPI) has gained 2.0 percent over the past year.
- Energy prices have been a different story lately. Over the past 12 months, energy prices declined by 9.4 percent, a key factor in keeping overall inflation down. Lately though, things have been very different. The energy sector of the CPI has gained about 7 percent since the end of February.
- Current personal loan rates leave little room for a rise in inflation. Not only has inflation been unusually low, but as a whole lenders have left themselves little cushion for the possibility of higher inflation. Loan rates represent a combination of an allowance for default risk (i.e., people failing to repay their loans), an adjustment for expected inflation, and a profit margin for the lender. Increase any of those factors – such as the inflation expectation – and you can generally expect loan rates to rise, though how immediately they respond depends on how big a margin lenders have already built into rates. So far in the 21st century, personal loan rates have averaged a margin of 9.33 percent over inflation. Currently that cushion is just 8.65 percent, suggesting that lenders will have little choice but to raise interest rates if inflation continues to rise.
The jury is still out on whether inflation will keep rising or will continue to settle back down. Lenders have to be very sensitive to inflation in setting their interest rates, so expect them to act promptly if evidence of rising inflation starts to mount. Any consumer considering a personal loan should make a decision before that has a chance to happen.