What the federal funds rate means to you
The federal funds rate, which is set by the U.S. central bank, is the interest rate at which banks borrow and lend to one another overnight. Although that’s not the rate consumers pay, the Fed’s moves still affect the borrowing and saving rates they see every day.
For starters, the rate hike will correspond with a rise in the prime rate and immediately send financing costs higher for many forms of consumer borrowing.
On the flipside, higher interest rates also mean savers will earn more money on their deposits.
What borrowers should know about higher rates
Short-term borrowing rates will be among the first to jump.
“With the Federal Reserve raising interest rates at an unprecedented pace, variable rate debts such as credit cards and home equity lines of credit will be the biggest exposure,” said Greg McBride, chief financial analyst at Bankrate.com.
Since most credit cards have a variable rate, there’s a direct connection to the Fed’s benchmark. As the federal funds rate rises, the prime rate does, as well, and credit card rates follow suit.
Annual percentage rates are currently just over 17%, on average, but could be closer to 19% by the end of the year, which would be an all-time high, according to Ted Rossman, a senior industry analyst at CreditCards.com.
That means anyone who carries a balance on their credit card will soon have to shell out even more just to cover the interest charges.
With this rate hike, consumers with credit card debt will spend an additional $4.8 billion on interest this year alone, according to an analysis by WalletHub. Factoring in the rate hikes from March, May, June and July, credit card users will wind up paying around $12.9 billion to $14.5 billion more in 2022 than they would have otherwise, WalletHub found.
As rates rise, the best thing you can do is pay down debt before larger interest payments drag you down.
If you’re carrying a balance, try calling your card issuer to ask for a lower rate, consolidate and pay off high-interest credit cards with a lower interest home equity loan or personal loan or switch to an interest-free balance transfer credit card.
“Zero-percent balance transfer offers can be a godsend for folks with credit card debt,” said Matt Schulz, chief credit analyst at LendingTree.
Adjustable-rate mortgages and home equity lines of credit are also pegged to the prime rate, but 15-year and 30-year mortgage rates are fixed and tied to Treasury yields and the economy. Still, anyone shopping for a new home has lost considerable purchasing power as rates almost doubled since the start of the year.
On a $300,000 loan, a 30-year, fixed-rate mortgage at December’s rate of 3.11% would have meant a monthly payment of about $1,283. Today’s rate of 5.54% brings the monthly payment to $1,711. That’s an extra $428 a month or $5,136 more a year and $154,080 more over the lifetime of the loan, according to Jacob Channel, the senior economist at LendingTree.
Even though auto loans are fixed, payments are getting bigger because the price for all cars is rising along with the interest rates on new loans, so if you are planning to buy a car, you’ll shell out more in the months ahead.
Paying an APR of 5% instead of 4% would cost consumers $1,324 more in interest over the course of a $40,000, 72-month car loan, according to data from Edmunds.
Federal student loan rates are also fixed, so most borrowers won’t be impacted immediately by a rate hike. But if you are about to borrow money for college, the interest rate on federal student loans taken out for the 2022-2023 academic year already rose to 4.99%, up from 3.73% last year and 2.75% in 2020-2021.
If you have a private loan, those loans may be fixed or have a variable rate tied to the Libor, prime or T-bill rates — which means that as the Fed raises rates, borrowers will likely pay more in interest, although how much more will vary by the benchmark.
What savers should know about higher rates
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The good news is that the interest rates on savings accounts are finally higher after several consecutive rate hikes.
While the Fed has no direct influence on deposit rates, they tend to be correlated to changes in the target federal funds rate and the savings account rates at some of the largest retail banks, which were near rock bottom since the start of the pandemic, are currently up to 0.10%, on average.
Thanks, in part, to lower overhead expenses, top-yielding online savings account rates are as high as 1.75% to 2%, much higher than the average rate from a traditional, brick-and-mortar bank.
As the central bank continues its rate-hiking cycle, these yields will continue to rise, as well. Still, any money earning less than the rate of inflation loses purchasing power over time.
“Savers are seeing better returns on savings accounts, money markets and certificates of deposit and additional rate hikes will sustain that momentum,” McBride said. “More importantly, inflation must come down in a substantial way for those higher savings returns to truly shine.”
What’s coming next for interest rates
Consumers should prepare for even higher interest rates in the coming months.
Even though the benchmark Fed funds rate is now back to where it was in July 2019, at the peak of the last cycle, inflation is still “running north of 9%,” McBride said. “We’re not at the finish line, and there will be more interest rate increases to come in the months ahead.”
Traders are betting the Fed will raise rates again at its next meeting in September and then again in November and December before possibly cutting rates in the spring, depending on the evolving economic conditions.
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