How the Federal Reserve affects personal loan rates

The Federal Reserve’s decisions can have a big impact on the cost of a personal loan. Changes to the federal funds rate — more commonly called the Fed rate — directly affect the rates lenders charge for most loans, and other Federal Reserve policies can encourage banks to accept or reject more loan applications.

Recently, the Federal Reserve has held rates at a steady 4.25% to 4.5%, due to market volatility and general economic uncertainty. But it’s possible that we’ll see rates fall before next year. A falling Fed rate won’t have any impact on current loans unless you have a variable rate, yet it could be a sign that it’s time to refinance.

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Quick explainer: What is the Federal Reserve?

The Federal Reserve is the nation’s central bank with a dual mandate to keep employment high and prices low by buying or selling government bonds, adjusting reserve requirements for banks and indirectly influencing interest rates for businesses and consumers. Unfortunately these monetary policy goals are at odds: The policies that create jobs increase prices, so the Federal Reserve’s job is to find a balance between the two.

When the Federal Reserve wants to create jobs, it buys government bonds, decreases reserve requirements and lowers interest rates. This makes it cheaper for banks and consumers to get their hands on credit, which encourages job creation and spending — but runs the risk of inflation.

When the Federal reserve wants to slow inflation, the Federal Reserve sells government bonds, increases reserve requirements and ups interest rates. While it’s great for savers, it helps reduce demand by making credit expensive and harder to get. When there’s less demand, there’s less of a reason for businesses to raise prices — but also less of a reason to hire new employees.

How does the Federal Reserve impact what you pay for a loan?

The Federal Reserve mainly affects the cost of a loan by raising or lowering the target range for the federal funds rate. This Fed rate is the interest rate that banks and financial institutions charge one another for overnight lending to maintain reserve requirements. Banks usually pass this cost on to their customers by adjusting their interest rates when the Fed funds rate changes. So, generally, when the Fed rate decreases, interest rates go down. When the Fed rate increases, interest rates go up.

There’s often a lag between changes to the Fed rate and interest rates on loans. So, for example, you have about a month after a Fed rate hike to snag the current rate on a loan. And if you’re waiting for a rate cut before you apply for a loan, you’ll typically need to wait about a week after the Fed rate drops for lenders to lower their rates.

Other Federal Reserve actions can also have an indirect impact on what you pay for a loan because they affect how much money is circulating in the economy. When there’s more money going around, interest rates typically fall — and vice versa.

🔍 Learn more: When’s the next Federal Reserve policy meeting? What to expect for your finances

How the Fed rate affects different types of loans

The Fed rate can have a slightly different impact on different types of loans, often depending on the type of interest rate you have:

• Personal loans have fixed interest rates, which remain the same for the full loan term. This means that changes to the Fed rate affect only new loans.

• Auto loans can have fixed or variable interest rates — which can change every month, quarter, six months or year. Fixed-rate auto loans will remain the same, but variable-rate auto loans will likely go up or down following a change to the Fed rate.

• Home equity lines of credit usually have variable rates, which change when the Fed adjusts interest rates. But if you have a fixed-rate HELOC, changes to the Fed interest rate can affect the rate you lock in during the draw period.

• Home equity loans typically come with fixed rates — and set when you take out the loan — so changes to the Fed rate generally affect only new loans.

• Personal lines of credit can have fixed or variable interest rates, so changes to the Fed rate only affect new fixed-rate credit lines and variable-rate lines.

• Student loans generally aren’t affected by the Fed rate unless you borrow money from a private lender: Congress sets federal loan rates based on the 10-year Treasury yield. But rates on new fixed-rate and all variable-rate private student loans change with the Fed rate.

• Mortgages are one of the few types of loans that don’t follow the Fed rate. Instead, mortgage rates are based on the 10-year Treasury yield, which typically shifts before the Fed rate sees a change.

🔍 Learn more: Personal loan vs. home equity loan: Which is the best fit for your financing?

What to consider if you’re applying for a personal loan

Applying for a personal loan when interest rates are low can help you save on the total and monthly cost of your loan. But it’s not the only factor that can affect your rate.

In addition to the Fed rate, here’s what lenders consider when calculating borrowing costs for your loan:

• Credit score. Generally the higher your credit score, the stronger your loan terms. Lenders typically require a score of at least 660, with the best personal loans reserved for borrowers who score 720 or higher.

• Debt-to-income ratio (DTI). To find your DTI, divide your total monthly debt payments by your monthly income before taxes. Lenders often won’t work with borrowers who have a DTI below 36%, though you’ll need a 20% DTI or under for the lowest rates.

• Employment history. Lenders will consider you more risky if you don’t have a full-time job with a reliable paycheck. Even if you have a high income, it can be hard for consultants or self-employed borrowers to get approved for a low loan rate.

• Cosigners. Not all lenders accept cosigners, but if yours does, bringing one on can help your chances of approval for a lower interest rate — especially if they have a higher credit score.

• Joint applicants. If the loan is for a shared expense — like a family car — applying with another borrower can help improve your chances for a lower rate by increasing your total income. Unlike cosigners, most lenders accept joint applications on all types of loans.

• Down payment. For loans to buy an asset like a house or a car, putting down a larger down payment can help you qualify for a lower interest rate.

• Loan term. Typically, lenders offer lower rates to borrowers who opt for a shorter term. It’s among the reasons you should choose the shortest term you can comfortably afford when applying for a loan.

• Loan amount. How much you borrow can also influence the interest rate you receive. Some lenders charge higher interest rates the closer you get to the maximum amount available.

🔍 Learn more: Best personal loans for 2025: Low rates, high maximums, flexible terms

Should you refinance your loan after Fed rates drop?

A Fed rate drop might make it easier to shave a few points off of your interest rate, but it’s not always guaranteed. While it depends on the type of loan you have, you can generally benefit from refinancing under these circumstances:

• Your credit score hasn’t changed or improved since you first borrowed.

• Your income hasn’t changed or improved since you first borrowed.

• Your DTI is the same or lower than it was when you first borrowed.

• The Fed rate is currently lower than it was when you first borrowed.

Even if you’re a perfect candidate for refinancing, you might not want to apply as soon as the Fed announces a rate drop. That’s because lenders can take a month or so to adjust to the new rate.

Also consider the drawbacks of refinancing the type of loan you have before you apply. For example, federal student loan borrowers will lose access to a wide range of safety net and forgiveness options when they refinance with a private lender. Refinancing your mortgage may require appraisal and have hefty closing costs that could wipe out your savings account. And if you lengthen your term to lower your monthly payments, you’ll often end up increasing the total cost of your loan — even if you qualify for a lower rate.

Make sure refinancing is worth the time and money involved before you apply. If you’re not sure if refinancing is a good choice, consider setting up a consultation with an accredited financial advisor.

🔍 Learn more: What is a debt consolidation loan — and can it help you lower your interest rate?

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FAQs: Personal loans, the Federal Reserve and your money

Find answers to more questions about the Federal Reserve’s impact on loans. And take a look at our growing library of personal finance guides that can help you earn money, save money and grow your wealth.

Can the Federal Reserve ever lower prices?

The Federal Reserve policies generally won’t lower prices — and you probably wouldn’t want them to anyway. The last time deflation occurred was during the Great Depression. During deflation, all assets lose value, including your house and your retirement savings. However, the federal government has several tools that it can use to lower prices for specific goods, such as price caps, subsidies and taxes.

How soon do credit card APRs change after a Fed rate decision?

Most credit cards come with variable APRs that move right along the federal funds rate. When the Fed increases this benchmark, credit card rates follow suit within one or two billing cycles. This movement can quickly raise interest charges on your existing credit card debt.

The same is true when the Fed cuts the benchmark: You should see lower interest charges on any balance you carry over monthly within one or two billing cycles.

Learn key steps to overcoming your monthly statements in our guide to paying down credit card debt.

Can I use a personal loan to pay my taxes?

If you’re facing a tax bill, a personal loan may offer a cheaper way out of tax debt over, say, a credit card. It could make the most sense if you’re able to secure a low rate, you have a good credit score and your bill is under $10,000. Learn more in our guide to paying your taxes with a personal loan — including pros, cons and alternatives to consider first.

How can I improve my relationship with money?

When it comes to money, it’s helpful to take a step back, acknowledge your emotions and weigh the risks and rewards for any money decision. Understanding the cognitive biases that may be fogging up your money mindset is a good place to start. You’ll also want a budgeting strategy that aligns with your lifestyle and values to provide focus on your financial goals. And, finally, it’s worth working with a trusted financial advisor that can help you manage your money as you plan for the long term — and give you peace of mind by assuring you that you’re on the right path.

How does the Federal Reserve encourage banks to loan more money?

The Federal Reserve encourages banks to loan more money by lowering the reserve requirements, buying government bonds and lowering interest rates. Lowering reserve requirements reduces the amount of cash that banks must have on hand, freeing up some of that money for loans. Buying bonds also allows banks to trade in securities for cash, freeing up even more money to lend to consumers and businesses. And lowering interest rates allows banks to spend less money on maintaining their cash reserves, which they can loan out to customers instead.

How does the Federal Reserve control lenders?

In addition to controlling the bond market, target Fed rate and reserve requirements for banks, the Federal Reserve also supervises and regulates financial institutes and enforces consumer protection laws. It also lends money to depository institutions to make sure that the financial system continues to run smoothly.

About our writer

Anna Serio-Ali is a trusted lending expert who specializes in consumer and business financing. A former certified commercial loan officer, Anna’s written and edited more than a thousand articles to help Americans strengthen their financial literacy. Her expertise and analysis on personal, student, business and car loans has been featured in Business Insider, CNBC, Nasdaq and ValueWalk, among other publications, and she earned an Expert Contributor in Finance badge from review site Best Company in 2020.

Article edited by Kelly Suzan Waggoner

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