Credit: forbes.com
On September 21, the Federal Open Market Committee (FOMC) announced another rate hike, raising the federal funds rate by 75 basis points (bps), to a range of 3% to 3.25%.
This move follows 75 basis-point hikes in June and July and two smaller rate hikes at the March and May meetings—all part of the central bank’s strategy to fight stubbornly high inflation. The FOMC will meet twice more in 2022.
“Recent indicators point to modest growth in spending and production,” the FOMC said in its post-decision statement. “Job gains have been robust in recent months, and the unemployment rate has remained low.”
Nevertheless, the central bank noted that “inflation remains elevated” thanks to “broader price pressures.”
The latest personal consumption expenditures price index (PCE) report showed that prices across the economy have risen 6.3% over the prior 12 months. Fed economists estimate that PCE inflation will remain high, but should decline to 5.4% by the end of 2022.
Unfortunately for stretched consumers, inflation can take a long time to return to normal, and it takes several months for the Fed’s policy changes to work their way through the economy—although some financial effects of its policies, such as higher interest rates on borrowed money, can be felt more quickly.
3 Ways The Fed Rate Increase Can Affect Your Money
1. Credit Card Interest Becomes More Expensive
When the Fed raises interest rates, your credit card debt becomes more expensive. That’s because the interest rates on consumer debt like carrying a balance on a credit card tend to move in lockstep with the fed funds rate.
This key interest rate impacts how many commercial banks charge each other for short-term loans. A higher fed funds rate means more expensive borrowing costs, which can reduce demand among banks and other financial institutions to borrow money.
The banks pass on these higher borrowing costs by raising the rates they charge for consumer loans. Most credit card issuers set your APR based on the prime rate, which is the rate banks charge the least-risky customers for loans.
Most credit cards charge a variable APR based on a combination of the prime rate plus a percentage on top of that to cover operating costs and make a profit.
The “variable” part means the interest rate you agree to pay when approved for a new card can fluctuate based on the prime rate. So if your credit card APR is 16.25% and the Fed increased its federal fund’s rate by 50 points, your issuer would likely raise your APR to 16.75%.
The higher the interest rate that’s applied to your credit card balance, the more expensive it is to carry that debt. Consider paying your debt down as much as possible or take advantage of a 0% APR balance transfer card to help reduce how much extra money you’ll pay on your debt.
2. Mortgages and Loans Become Costlier
Another Fed rate hike means that those borrowing to buy a house or to tap their current home equity will likely face a bigger housing bill in the coming months.
Some economists had forecast that rates hit their peak in the summer, when the 30-year fixed mortgage reached 5.81% in mid-June, then fell as low as 4.99% by August. At the time, most forecasters say rates would land in the low 5% by year-end. But that was before rates hit a new 14-year high of 6.02% last week.
Shorter-term home loans with floating rates like adjustable-rate mortgages (ARMs) and home equity lines of credit (HELOCs) are tied to the Fed funds rate, so when that rate goes up, ARM and HELOC rates soon follow.
ARMs have an initial phase during which the rate is fixed—typically for five years—before transitioning to a rate that adjusts annually. The rates for ARMs are currently lower than traditional fixed-rate mortgages, which have roughly doubled since last year.
As far as fixed-rate mortgages go, the recent rise in fixed mortgage rates is a combination of Fed policy, recessionary concerns, and inflation.
Longer-term mortgage rates are more so impacted by the 10-year Treasury yield. When the yield rises, so do rates.
The Fed’s latest rate hike is a potential trigger for recession, which prompts investors to park their cash in safe-haven assets like the 10-year Treasury note. Similarly, rising inflation usually drives rates higher as lenders have to offset borrowers’ diminishing purchasing power.
But not everyone thinks higher mortgage rates are a terrible thing. Some real estate professionals see higher rates as one way to cool an overheated housing market. Others think it’s time to get back to normalcy after two years of artificially low borrowing costs.
“Interest rates, even though they’re higher than the past few years, are still relatively modest. We’ve really been spoiled,” says William Lublin, owner of the Century 21 Advantage Gold office in Southampton, Pennsylvania.
For shoppers who’ve stepped out of the house hunt hoping that rates will come down, Lublin says doing so is “like trying to catch a falling knife.”
Housing experts say borrowers should consider locking in their interest rate before rates climb higher. Rate locks typically last 30 days, but some lenders offer longer locks, usually for a fee. It’s difficult to predict for certain whether you have locked in the lowest rate possible, but there’s always the option of refinancing later if rates decline.
“If rates do come down, [home buyers] have the benefit of having bought at these prices and can always refinance,” Lublin says. “You can’t go back in time and buy a home at a lower price.”
As for student loans, some private loans are influenced by Fed rates, so there’s a possibility the interest rates on those could rise. All in all, it’s a good time to make sure you understand the loans you have and consider refinancing them before rates increase more—but only if the cost to refinance is still worth the savings overall.
3. Rates on Savings Accounts Climb, Though Slowly
A higher fed funds rate is a boon to savers, who have been seeing the rates on savings accounts creep higher.
There’s no direct connection between federal funds and deposit rates. But banks are slowly increasing the annual percentage yield (APY) they pay on deposit accounts—including savings accounts, money market accounts, and certificates of deposit (CDs).
Financial institutions raise their rates to attract deposits, but they currently have plenty of cash on hand and can take their time hiking yields.
How quickly you’ll see higher APYs on deposits depends on where you bank. Online banks, smaller banks, and credit unions typically offer more attractive yields than big banks and have generally been increasing rates faster because they have to compete more for deposits.
Putting your money into an online bank or credit union may be your best bet if you’re looking for a higher yield. While the national average rate on a savings account has jumped from 0.06% to 0.17% since January, according to the FDIC, the best high-yield savings accounts pay up to 5% APY on some deposits. Where you park your cash matters, especially during times of increasing inflation.