The Federal Reserve is the central bank of the United States
and is charged by Congress to maintain a stable economy and financial system.
One of the ways the Fed does this is by increasing and
lowering the cost of borrowing money. Interest rate cuts are intended to
encourage more borrowing and spending by people and companies. That spending,
in turn, tends to accelerate growth and energize economies. Lower mortgage
rates, for example, typically lift home sales. And cheaper borrowing can lead
businesses to take out loans and expand and hire.
Conversely, interest rate increases helps contain inflation
as consumers spend less when the cost of borrowing rises.
The Fed raised its benchmark interest rate Wednesday by one
quarter of a percentage point, its first rate increase in three years, and
signaled up to six additional increases this year. The rate hikes will
eventually mean higher loan rates for many consumers and businesses.
Here are some ways the Fed hike could impact your wallet:
How Fed hikes affect credit card interest rates and
borrowing costs
Most credit cards have variable interest rates and those are
tied to the financial institution's prime rate, which is the rate that banks
charge their more creditworthy customers. The prime rate is based on the Fed's
benchmark rate, which is the overnight rate banks charge each other to lend
money in order to meet mandated reserve levels. When benchmark rates go up, it
becomes more expensive for banks to borrow money and they pass those costs on
to consumers in the form of higher interest rates on lines of credit.
A rate hike would increase interest rates for cardholders
and borrowers with variable APRs. While a quarter point increase might not spur
financial ruin for borrowers with low balances, those with larger credit debts
will likely feel the impact at time when the cost of living is already surging.
And with the Fed expected to raise its benchmark rate to between 1.75% and 2%
by year's end, many more could be stuck paying higher interest on their
balance.
“The impact of a single quarter-point interest rate hike is
inconsequential on the household budget," Bankrate.com's chief financial
analyst Greg McBride told CNBC. "But the cumulative effect of rate hikes
is what is really going to have an impact on both the economy and household
budgets."
Bankrate.com advises consumers to consider balance transfer
card options to pay off their credit card debt. Finding a card that offers zero
percent interest on balance transfers and paying off your charges within the
introductory zero percent APR window is one way to eliminate your debt without
interest.
Credit card interest rates are currently around 16.34%,
according to Bankrates.com.
Will the Fed increase affect mortgage rates?
The impact of the Fed rate cut on home loans depends on
whether the borrower has a fixed or adjustable-rate mortgage (ARMs), and even
then, only slightly. That's because the Fed rate and mortgage rates are not
directly linked.
A home loan is a long-term financial product, the most
common being a 30-year fixed-rate mortgage, while the Fed rate is for
short-term overnight borrowing. Long-term mortgage rates are pegged to yields
on government bonds, especially the 10-year Treasury note, according to
CNBC.com. When that rate goes up, the popular 30-year fixed rate mortgage tends
to do the same.
Because of faster inflation and strong U.S. economic growth,
those Treasury notes are up. In turn, the average rate for a 30-year home
mortgage has already risen to 3.85% from 3.11% in late December.
Global turmoil, like Russia's invasion, often spurs
investors to buy up U.S. Treasurys, which are regarded as the world's safest
asset. Higher demand for the 10-year Treasury would lower its yield, which
would then reduce mortgage rates.
Rates for fixed mortgages are also influenced by supply and
demand. When business is booming for mortgage lenders, they raise rates to
decrease demand. When fewer people are taking out mortgages, lenders cut rates
to attract more customers.
ortgage rates are ultimately set by the investors. Most U.S.
mortgages are packaged as securities and resold to investors. Lenders offer
consumers an interest rate that third party investors are willing to pay.
What about car and student loans?
Auto loans are not expected to be impacted by the Fed rate
hike because most are usually fixed-interest loans. However, lenders tend to
increase their rates when the Fed rate changes, making new purchases a bit more
expensive — but not by much.
A quarter percentage point difference on a $25,000 loan is
$3 a month, McBride notes.
“Nobody is going to have to downsize from the SUV to the
compact because of [interest] rates going up,” he told CNBC.
As for student loans, all government-held federal student
loans have been in a payment pause, with interest suspended, since March 2020
due to the coronavirus pandemic. That relief was originally scheduled to end on
January 31, 2022, but in December President Joe Biden extended that relief
further to May 1. Any interest rate increase by the Fed will have no impact on
these loans. Additionally, Congress establishes federal student loan interest
rates through legislation, which it updates periodically, and not the lenders.
But, borrowers with a private loan may have a fixed or a
variable rate tied to the Libor, London InterBank Offered Rate, another key
interest rate used by banks for short-term lending with other banks, according
to CNBC. That means as the Fed raises rates, borrowers will likely pay more in
interest, although how much more will vary by the benchmark and lender.
What about the return on my savings?
Savers won't benefit directly from the Fed rate increase
because deposits generally are slow to respond to interest rate hikes. Plus,
savings account rates are at historic lows, and any minor increases won't hold
much purchasing power because of rising inflation.
The FDIC reports that the average rate paid on savings
accounts in the U.S. is a mere 0.06% for a brick-and-mortar institution. The
Associated Press reports these large banks have been flooded with savings as a
result of government financial aid and reduced spending by many wealthier
Americans during the pandemic. They won't need to raise savings rates to
attract more deposits or CD buyers
Some online lenders, however, have been competing to offer
higher yield savings accounts with rates hovering around 6%, according to
Bankrates.com. The only catch is that they typically require significant
deposits.
Consumers who find themselves worried about an economic
downturn should still take steps now to shore up their finances, regardless of
rates. That includes paying down debt, refinancing at lower rates and boosting
emergency savings.
If you're invested in mutual funds or exchange-traded funds
that hold long-term bonds, they will become a riskier investment. Typically,
existing long-term bonds lose value as newer bonds are issued at higher yields.
Click here for the
original article.