The US Federal Reserve on Wednesday raised interest rates by 0.75 percentage points for the fourth straight day, marking an unprecedented pace of rate hikes.
The US Federal Reserve has raised the benchmark short-term interest rate six times this year, including hikes of 75 basis points in June, July and September, to cool inflation, which is still near 40-year highs, leading to that most consumers feel increasingly cash-strapped. One basis point corresponds to 0.01 percentage points.
A policy statement following the announcement noted that the Fed considers the “cumulative” impact of its past rate hikes when setting future rate hikes. Economists hope this signals plans to “decelerate” the pace of future hikes, which could mean a half-point hike at the December meeting and then some smaller hikes in 2023. Still, stocks fell after Federal Reserve Chair Jerome Powell said more rate hikes were imminent.
“Americans are under greater financial stress, there’s no question about that,” said Chester Spatt, professor of finance at Carnegie Mellon University’s Tepper School of Business and former chief economist for the Securities and Exchange Commission.
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“However, when the Fed tightens, it will also have an adverse impact on everyday Americans,” he added.
What the Federal Funds Rate means to you
The federal funds rate, set by the central bank, is the rate at which banks lend and borrow money from each other overnight. While that’s not the rate consumers are paying, the Fed’s moves are still impacting the lending and savings rates they see every day.
By raising interest rates, the Fed makes it more expensive to borrow, causing people to borrow less and spend less, effectively slowing the economy and slowing the pace of price increases.
“Unfortunately, the economy will slow much faster than inflation, so we’ll feel the pain before we see any gains,” said Greg McBride, chief financial analyst at Bankrate.com.
“Mortgage rates are already up to 16-year highs, home equity credit lines are at their highest in 14 years and auto loan rates are at 11-year highs,” he said.
How higher interest rates affect borrowers
• Mortgage rates are already higher. Although 15- and 30-year mortgage rates are fixed and linked to Treasury yields and the economy, anyone who buys a home has lost significant purchasing power, in part due to inflation and Fed policies.
Coupled with the central bank’s pledge to crack down on inflation, the average interest rate on the 30-year fixed-rate mortgage hit 7%, up from under 4% in March.
On a $300,000 loan, a 30-year fixed-rate mortgage at a rate of 3.11% would have meant a monthly payment of about $1,283 in December. Today’s rate of 7.08% brings the monthly payment to $2,012. That’s an additional $729 per month, or $8,748 more per year, and $262,440 more over the life of the loan, according to LendingTree.
The rise in mortgage rates since early 2022 has the same affordability impact as a 35% rise in house prices, according to McBride’s analysis. “If you got a $300,000 mortgage earlier this year, that’s less than $200,000 today.”
For home buyers, “adjustable rate mortgages may continue to be more popular among consumers who want lower short-term monthly payments,” said Michele Raneri, vice president of U.S. research and advisory services at TransUnion. “And consumers looking to tap available home equity may continue to look to HELOCs,” she added, rather than refinancing.
However, adjustable-rate mortgages and home equity lines of credit are tied to the prime rate, so they will rise as well. Most ARMs adjust once a year, but a HELOC adjusts instantly. The average rate for a HELOC is already 7.3% versus 4.24% at the start of the year.
• Credit card fees are increasing. Since most credit cards have a variable interest rate, there is a direct link to the Fed’s benchmark. When the federal funds rate goes up, so does the federal funds rate, and your credit card rate follows within a billing cycle or two.
So if you have credit on your credit card, you’ll soon have to shell out even more just to cover the interest. “This latest rate hike will hit those consumers who aren’t fully paying off their credit card balances through higher minimum monthly payments the hardest,” Raneri said.
Because of this rate hike, consumers with credit card debt will spend an additional $5.1 billion on interest, according to analysis by WalletHub. Factoring in March, May, June, July, September and November rate hikes, credit card users will pay around $25.6 billion more than usual in 2022, WalletHub found.
Credit card rates are already close to 19%, up from 16.34% in March. “That’s the highest reading since the Fed began tracking it in 1994 and more than a full percentage point higher than the previous record set in 2019,” said Matt Schulz, chief credit analyst at LendingTree. And interest rates will only keep going up, he said. “We still have a long way to go before these rates peak.”
The best thing you can do right now is pay off expensive debt – “0% balance transfer credit cards are still widely available, especially for those with good credit histories, and can help you recover accrued interest on the transferred balance for up to 21 months to avoid,” Schulz said.
“This can be an absolute godsend for people struggling with card debt,” he added.
Otherwise, consider consolidating and paying off high-yield credit cards with a lower-interest home equity loan or personal loan, Schulz advised.
• Car loans are more expensive. Even though car loans are locked in, the payments keep getting larger as the price of all cars increases along with interest rates on new loans. So if you are planning to buy a car, you will pay more in the coming months.
The average interest rate on a five-year new-car loan is currently 5.63%, up from 3.86% at the start of the year, and could top 6% with the central bank’s next moves, although consumers with better credit ratings may be able to secure better loan terms.
According to Edmunds data, paying an APR of 6% instead of 5% would cost consumers $1,348 more in interest over the course of a 72-month $40,000 car loan.
Still, it’s not the interest rate but the vehicle’s sticker price that creates an affordability issue, McBride said. “Rising interest rates certainly won’t help.”
• Student loans vary by type. State student loan rates are also fixed, so most borrowers are not immediately affected. However, if you want to borrow money for college, the interest rate on federal student loans taken for the 2022-2023 academic year is up to 4.99%, up from 3.73% last year and 2.75% in 2020-2021 .
If you have a personal loan, these loans can be fixed or variable rates tied to Libor, Prime, or T-Bill interest rates, meaning borrowers are likely to pay more interest when the Fed raises interest rates increased, although how much more varies by benchmark.
Currently, average fixed rates for personal student loans can range from 3.22% to 14.96%, and variable rates from 2.52% to 12.99%, according to Bankrate. As with car loans, they vary widely based on creditworthiness.
Of course, anyone with existing educational debt should see where they stand with federal student loan forgiveness.
How higher interest rates affect savers
• Only some savings account rates are higher. The silver lining is that 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 correlate with changes in the target federal funds rate and savings account rates at some of the largest retail banks, which have been near bottoming out for most of the Covid-19 crisis. 19 pandemic currently averages up to 0.21%.
Thanks in part to lower overheads, high-yield online savings account rates are up to 3.5%, much higher than the average rate at a traditional bank, according to Bankrate.
“Savers are seeing the best returns since 2009 — if they’re willing to look around,” McBride said. However, since the inflation rate is now higher than any of these rates, any savings lose purchasing power over time.
Now’s the time to step up those emergency savings, McBride advised. “Not only will you be rewarded with higher rates, but nothing helps you sleep better at night than knowing you have some money hidden just in case.”
“Overall, it makes sense to be more cautious,” Spatt added. “Note that employment may be less secure. It is reasonable to expect unemployment to rise, but how much remains to be seen.”
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