Four quarter-point rate hikes from the Federal Reserve Bank with one more pending at the end of the year have raised average debt consolidation loan rates from 10.28% in January to 11.31% in September. Expect them to rise slightly more as we go into the new year and then remain stable throughout 2024. In this article, we’ll unpack how these changes will impact consumers.
Keep in mind what we’re going to lay out for you is based on projections. Neither the Federal Reserve Bank nor any of the lenders who specialize in debt consolidation can predict the direction the economy will go in over the next 12 months. The Fed will make decisions about whether to raise or lower rates based on that economic movement.
How does the Federal Funds Rate affect Loan Rates?
The rate that the Federal Reserve Bank controls is called the federal funds rate. That’s not the same as debt consolidation loan rates. The FFA is what banks charge other banks when they need to borrow from each other. Consider it a starting point to calculate other lending rates.
The federal government requires that all banks maintain a certain balance of money to protect them from bank runs that could make the bank insolvent. In return, the government provides FDIC insurance to protect consumers. When the Fed raises the FFA, it makes it more expensive for banks to borrow when they need to replenish their reserves.
Like any other business, a bank is going to pass its costs along to its customers. The federal funds rate might not directly affect debt consolidation loan rates, but it does help to determine the prime rate that lenders offer to their most qualified borrowers. That rate is the baseline that’s used when you apply for a debt consolidation loan.
What is the Current Prime Rate and will it go up?
The current prime rate at the time of this writing is 8.50%. As we already stated above, the average for all debt consolidation loan rates is 11.31%. That’s 2.81% over prime. Expect that to go up slightly before the end of the year if the Fed follows through on their estimate that there will be one more rate hike in 2023, followed by two cuts in 2024.
The current federal funds rate is 5.50%. Assume that it will be 5.75% entering the new year. Based on the math we’re already seeing, that should put the prime rate at 8.75% entering 2024. Average debt consolidation loan rates will likely creep up closer to 12%, assuming the status quo for borrower qualification criteria remains the same.
Loan rates aren’t the only area affected by the prime rate. Credit card interest rates also go up and down based on the prime rate. Read your credit agreement carefully to find the exact formula they use. Paying 12% for a loan will seem a lot less daunting after you do that. According to Forbes, the average credit card interest rate is currently 28.05%.
HELOC Interest Rates are at 9.10%
Like personal loan rates, the interest rate on a home equity line of credit (HELOC) is also determined by the prime rate and therefore directly affected by the federal funds rate. That means the next Fed decision could make it more or less expensive to borrow against your home’s equity. According to Bankrate, the current average rate for a HELOC is 9.10%.
The downside to using a HELOC instead of an unsecured personal loan is that your home is the collateral you’re putting up as a guarantee of repayment. Defaulting on the HELOC could put you in jeopardy of losing your home. This is very different from other debt consolidation or debt repayment strategies you can employ.
Another drawback to using a HELOC now is that interest rates aren’t likely to go up too much more than their current levels. Two cuts are already projected for next year. Can you afford to wait? Debt consolidation loan rates will come down again when those cuts are announced. Credit card interest rates should be lower also.
Rise in Bankruptcies Could be a Factor
The United States courts published a report in June 2023 stating that personal and business bankruptcies rose 10% over the previous 12 months. Rising costs due to inflation were a major contributor to that change. High interest rates on debt were another. Lenders understand these issues and factor it into their risk assessments when screening borrowers.
Debt consolidation is certainly a more appealing option than Chapter 7 or Chapter 11 bankruptcy, but many consumers pursuing consolidation options are already on the brink of filing for bankruptcy. That and the statistics released by the U.S. courts have led to tougher criteria and higher interest rates for applicants with less-than-perfect credit.
Personal loan rates for bad credit or even for fair credit borrowers currently range up to 36%. A higher prime rate in 2024 could push that number over 40%, making bankruptcy a more appealing option. Expect to see some pushback in this area that could affect how the Fed comes to its future decisions on raising rates.
What Happens if We Go into Recession?
Increasing interest rates in 2023 has failed to cause the economy to slow down, but that could change quickly. If the country goes into a recession, the Fed will likely start lowering rates again. That will happen gradually, but it will eventually bring down debt consolidation loan rates. For borrowers, that may be a best-case scenario.
The worst-case scenario is that the country goes into recession and the Fed refuses to lower interest rates. The cost of debt would remain high and options for consumers would be limited. That’s unlikely to happen, but it’s certainly a possibility. Continue to check Another Second Opinion on this and other economic issues.