SFN Blog

The Impact of Federal Reserve Policies on Personal Loans

When people borrow money for personal needs, like medical bills, home repairs, or debt consolidation, they often take out a personal loan. These loans are typically unsecured, meaning they don’t require collateral like a house or car. One important factor that affects how much borrowers pay in interest is something most people don’t think about much: the Federal Reserve, or “the Fed.”

The Federal Reserve is the central bank of the United States. It helps manage the economy by setting interest rates and controlling the money supply. What the Fed decides can make personal loans more expensive or cheaper. It can also make it easier or harder for people to get approved for one.

In the U.S., personal loan balances reached $241 billion in the first quarter of 2025, a 15.6% increase from the year before. The average interest rate for a 24-month personal loan from a commercial bank was 12.49% as of May 2025, according to the Federal Reserve itself. At the same time, more Americans are turning to personal loans for flexible borrowing options compared to credit cards or payday loans.

As interest rates rise or fall, so do the rates on personal loans. That’s why it’s important for both lenders and borrowers to understand how Federal Reserve policies affect the cost and availability of these loans.

Understand Federal Reserve Policies

Let’s break down everything you need to know about FR policies:

Monetary Policy Tools

The Fed uses several tools to influence the economy:

  • Federal Funds Rate: This is the interest rate at which banks lend money to each other overnight. It serves as a benchmark for many other interest rates, including personal loans.
  • Open Market Operations: This means buying or selling government securities to adjust the amount of money in the banking system.
  • Reserve Requirements: The amount of money banks must keep on hand. Changing this affects how much they can lend.

Goals of Fed Policy

The Fed has three main goals:

  • Control inflation: Keeping prices stable.
  • Promote employment: Helping the economy grow without overheating.
  • Stabilize the financial system: Making sure banks stay strong and people trust the financial system.

How the Federal Funds Rate Affects Lending

Here is how rates of FF may change the lending perspective:

Interest Rates and Loan Costs

When the Fed changes the federal funds rate, it influences how much it costs banks to borrow money. When that cost goes up, banks usually pass those costs on to consumers through higher interest rates on loans, including personal loans.

For example, if the Fed raises the federal funds rate by 0.25%, banks may increase personal loan rates by a similar amount. On the flip side, if the Fed lowers the rate, banks may offer cheaper loan rates.

Example Scenarios

Rising Rates: Let’s say you want a $10,000 loan over 3 years. If the interest rate goes from 9% to 12%, your monthly payment increases by about $50, and you pay nearly $1,800 more over the life of the loan. If the Fed cuts rates, you might get that same loan at 8% instead of 12%, saving you thousands in interest.

Bank Behavior and Lending Standards

Banks don’t just react to interest rates. They also change their lending standards when lending money.

Risk Tolerance

When the Fed raises rates, banks often become more cautious. Higher rates can slow down the economy, leading to job losses and late payments. Banks may:

  • Require higher credit scores
  • Ask for more income proof
  • Offer smaller loan amounts

Looser Standards in Easy Money Times

When rates are low and the economy is strong, banks may relax their standards. That means more people can qualify for personal loans, even with average credit.

Impact on Borrowers

Yes, the borrowers are also affected. Here is how:

Cost of Borrowing

The biggest effect is on how much it costs to borrow.

  • Higher Rates: You pay more every month and more in total.
  • Lower Rates: You save money, and your payments are easier to manage.

Access to Credit

Fed policy can make it easier or harder to get a personal loan:

  • Tight Policy: Fewer people get approved.
  • Loose Policy: More people get approved, sometimes even with lower credit scores.

Strategic Timing for Borrowers

If the Fed hints at raising rates soon, it might be smart to lock in a personal loan while rates are low. On the other hand, if rates are high but expected to drop, waiting could save you money.

Indirect Effects

Fed policies affect more than just interest rates. Here’s how:

  • Employment: If the Fed raises rates to cool the economy, some businesses may slow hiring or cut jobs.
  • Wages: Slower job growth can keep wages from rising.
  • Consumer Confidence: People spend less when they worry about jobs or the cost of borrowing.

All of this impacts how likely someone is to take out a personal loan and their ability to repay it.

Recent Trends and Case Study

In 2022 and 2023, the Fed raised rates several times to fight inflation. Personal loan rates followed. The average interest rate for excellent-credit borrowers went from around 10% in early 2022 to over 14% by late 2023.

At the same time, banks tightened lending standards. Many borrowers found it harder to qualify, and those who did faced higher costs.

In early 2025, with inflation easing, the Fed began signaling it might pause or reduce rates. If this continues, personal loan rates may slowly drop, and access to credit may improve.

Tips for Consumers

Check what you should do to know the impact on personal loans:

Monitor Fed Policy

You don’t need to be an economist. Just pay attention to major headlines about the Fed. Look for changes in the federal funds rate and Fed speeches about inflation or the economy.

Fixed vs. Variable Rate Loans

Most personal loans have fixed rates, which means your interest doesn’t change. But if you’re offered a variable rate, remember that your payments can go up if the Fed raises rates.

Improve Your Credit

Strong credit helps you qualify for lower rates, even if the Fed raises its benchmark. Do things like pay bills on time, lower your credit card balances, and avoid applying for too much credit at once.

Conclusion

The Federal Reserve doesn’t set personal loan rates directly. But its policies shape how much loans cost and who can get one. When the Fed raises or lowers interest rates, banks respond. That response affects your wallet.

If you understand how Fed decisions work, you can make smarter choices about borrowing. Keep an eye on rate trends, improve your credit, and time your loan applications wisely. In the end, a little knowledge can help you save a lot.