What is a good interest rate on a personal loan?
A competitive rate will vary depending on market conditions and your credit score
When applying for a personal loan, the interest rate is a major factor in determining which lender to go with. That’s because when you qualify for a lower interest rate, your monthly payments and the cost of the loan overall are lower.
According to the Federal Reserve, the average personal loan interest rate on a two-year loan was 12.17% as of August 2023. But that amount will vary depending on how much you borrow and your creditworthiness.
Key insights
- Interest rates determine your monthly payment and the total cost of the loan.
- One of the biggest factors in determining your personal loan’s interest rate is your credit score.
- If your score isn’t very high, you’ll need to take steps like putting down collateral or getting a co-signer to qualify for lower rates on personal loans.
What is considered a good interest rate?
While the Federal Reserve reports the average two-year personal loan rate at 12.17% as of August 2023, interest rates can vary widely depending on the type of loan, the repayment term, your credit score and if you have any assets securing the loan.
Your credit score, in particular, has a big impact on what rate you’ll be quoted. For example, loan aggregator Credible says that based on its marketplace as of September 2023, the average fixed interest rates on five-year personal loans by credit score are:
| Credit score range | Typical interest rates |
|---|---|
| 780+ | 17.67% |
| 720 to 779 | 21.25% |
| 680 to 719 | 23.75% |
| 640 to 679 | 27.01% |
| 600 to 639 | 28.81% |
| >599 | 30.00% |
Keep in mind that some lenders charge application fees, origination fees and other fees that can impact the total cost of your loan. These fees are factored into the loan’s annual percentage rate (APR), which may differ from its interest rate. When evaluating your loan options, compare both the interest rate and the APR to find the best deal.
Also watch out for predatory rates that take advantage of struggling borrowers. ConsumerAffairs considers rates over 35.99% to be predatory. If you cannot qualify for a lower interest rate, take steps to improve your credit score or financial situation before taking out a personal loan.
How are interest rates determined?
Interest rates on personal loans take into consideration numerous factors. In general, lenders adjust interest rates based on the risk they take on when issuing the loan.
While each lender uses different criteria and weighs them according to their needs, these are the primary factors a bank considers when determining your personal loan interest rate:
- Cost of funds. This is the interest rate the lender pays depositors or the Federal Reserve for the money it lends to borrowers. Many loans are based on the prime rate, so when the Federal Reserve raises rates, it affects the rates borrowers pay.
- Fixed or variable rate. Fixed rates offer a constant interest rate throughout the loan term, while variable rates adjust based on economic conditions. Locking in a fixed rate usually results in higher initial rates than a variable-rate loan — but with a variable rate, you risk an unknown rate in the future should the market shift.
- Loan type. The type of loan affects interest rates. Loans secured by assets, such as a home or vehicle, typically offer lower rates than an unsecured loan.
- Loan amount. The larger the sum of money, the greater the risk of loss to the bank. Only borrowing what you need can yield a lower interest rate.
- Repayment term. Generally, loans with longer repayment terms have a higher risk of default versus shorter terms, so lenders will charge a higher interest rate.
- Credit score. Credit scores are a representation of your credit risk based on your payment history, credit utilization and other factors. Higher credit scores typically qualify for the best interest rates.
» MORE: What affects your credit score?
Why is interest rate important?
The interest rate is one of the biggest factors in determining your monthly payment. Higher monthly payments can affect your debt-to-income ratio (DTI). Your DTI could determine which loan programs you’re eligible for, what fees you’re charged and the terms of your loan.
This table highlights the potential difference in monthly payments for three borrowers with different credit scores. Each borrower is applying for a $20,000 personal loan to be repaid over five years. Additionally, it shows how much interest each one pays over the life of the loan.
| Excellent credit | Good credit | Fair credit | |
|---|---|---|---|
| Loan amount | $20,000 | $20,000 | $20,000 |
| Interest rate | 17.67% | 23.75% | 28.81% |
| Monthly payment | $504.28 | $572.46 | $632.53 |
| Total interest paid | $10,257.10 | $14,347.65 | $17,951.56 |
As you can see, a lower credit score can result in a much higher monthly payment, as well as a drastically higher cost of the loan overall — nearly double the total interest paid if you only have fair credit (a FICO score of 580 to 669) versus excellent credit (a FICO score over 800).
Jon Morgan, CEO of Venture Smarter, said that interest rates are a "critical factor in determining the cost of borrowing for a personal loan. A lower interest rate can lead to lower overall repayment amounts, making the loan more affordable and manageable for the borrower."
How to get the best interest rate possible
To keep your interest rate and the overall cost of your loan low, Morgan recommends that you "focus on maintaining a high credit score, managing existing debts responsibly, showcasing a stable income and selecting a suitable repayment term based on your financial capacity."
Before you apply for any loan, check your credit score. There may be some erroneous items on your file that you can remedy (such as unreported payments or closed accounts still showing as open) to help boost your score.
Additionally, paying down any credit card balances is one of the fastest ways to improve your score — and therefore your potential interest rates. Ideally, the balance on each credit card should be 30% or less of your credit limit.
Here are some other ways to improve your chances of getting a lower interest rate:
- Check different lenders. Compare lenders (at least three) before committing to one. Thankfully, credit bureaus understand that borrowers like to shop around, so multiple applications within a short time for the same type of loan only count as a single inquiry.
- Secure the loan. Putting down collateral on a secured loan can help to reduce your interest rate. Eligible assets may include your home, automobile, investments or bank balances. The loan type you apply for often dictates the collateral you’ll use. For example, when using your home, you’ll apply for a home equity loan.
- Apply with a co-signer. Adding a co-signer with stronger credit, higher income or more assets can strengthen your application. This is especially true if you’re new to credit or have negative marks on your credit report. Because the co-signer is responsible should you default, you can often qualify for a lower interest rate.
FAQ
How low can interest rates go?
Interest rates on loans have a limit on how low they can go because of funding costs, operating costs, profit margins and other factors. Even when the Fed funds rate was near 0% for almost a decade, personal loan interest rates remained elevated to account for the risk of borrower default. If you have a fixed-rate loan, the rate will not change if rates go up or down. Variable-rate loans often have a minimum floor that interest rates cannot go below.
What does “prime rate” mean?
The prime rate is the index that many lenders use as a base interest rate for their variable loans. It is typically 3% higher than the Federal funds rate, which is the rate that the Federal Reserve charges banks for overnight loans. Variable-rate loans and credit cards usually charge the prime rate plus a margin. For example, a home equity line of credit may charge an interest rate of prime plus 1% to 2%.
What’s the difference between an interest rate and an APR?
A loan’s interest rate is the interest charged by a lender. The APR factors in the origination fees and other costs, in addition to the interest rate. Check the APRs offered among lenders for a more equitable comparison when deciding which loan to choose.
What type of personal loan has the highest APR?
Payday loans are often the personal loans with the highest APR. These loans have short repayment terms with significant fees. The APR of payday loans can reach up to 400% or higher.
Bottom line
When borrowing money, getting a good interest rate lowers your monthly payment and reduces the overall cost of the loan. But interest rates are based on a number of factors, including your credit score, repayment term and type of loan.
You can improve your odds of getting a good rate by improving your credit score, shortening the loan term and other strategies. Shop a few lenders to compare your options and find the best terms for your borrowing needs.
Article sources
- Board of Governors of the Federal Reserve System, " Consumer Credit - G.19 ." Accessed Oct. 27, 2023.
- Credible, “ Personal Loan Interest Rates Rise for 3-Year Loans While 5-Year Loans Fall .” Accessed Oct. 30, 2023.
- Consumer Financial Protection Bureau, " What is the difference between an interest rate and the Annual Percentage Rate (APR) in an auto loan? " Accessed Oct. 27, 2023.
- Capital One, " What is a credit utilization ratio? " Accessed Oct. 27, 2023.
- Equifax, " Understanding Hard Inquiries on Your Credit Report ." Accessed Oct. 27, 2023.
- Veridian Credit Union, " What is a 'variable rate' loan? " Accessed Oct. 27, 2023.
- Bank of America, " What is a home equity line of credit (HELOC)? " Accessed Oct. 27, 2023.
- Consumer Financial Protection Bureau, " What is the difference between a mortgage interest rate and an APR? " Accessed Oct. 27, 2023.
- Credit Karma, " 8 different types of loans you should know ." Accessed Oct. 27, 2023.
