The Federal Reserve raised interest rates by a quarter point on Wednesday in its continued effort to contain inflation.
In a move that financial markets had fully priced in, the central bank’s Federal Open Market Committee raised interest rates to a target range of 5.25% to 5.5%. The middle of this target range would be the highest level in the policy rate since early 2001.
After keeping interest rates steady at the last meeting, the central bank indicated that the struggle to contain inflation is not over, despite recent signs that inflationary pressures are easing.
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Inflation remains above the Fed’s 2 percent target for now; “However, it’s entirely possible that this could be the last hike in the cycle,” said Brett House, an economics professor at Columbia Business School.
What the Federal Funds Rate means to you
The Federal Funds Rate, set by the US Federal Reserve, 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 actions are affecting the interest rates on loans and savings consumers see every day.
This hike – now the 11th rate hike since March 2022 – will coincide with a rise in the policy rate and immediately raise the cost of financing many forms of consumer borrowing, putting pressure on households hoping to avoid a possible recession.
“The pain that the rate hike has caused many people is not unfounded,” House said. “Ultimately, this is a trade-off between pain now and greater pain later if inflation is not brought under control.”
How higher interest rates can affect your money
1. Credit card fees are at record highs
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Since most credit cards have a variable interest rate, there is a direct link to the Fed’s benchmark. When the federal funds rate rises, so does the federal funds rate, and credit card rates follow that trend within a billing cycle or two.
According to a report by Bankrate, the average credit card interest rate is now more than 20% — an all-time high, while balances are higher and nearly half of cardholders have card debt on a month-to-month basis.
Overall, this rate hike will cost credit card users at least $1.72 billion in additional interest costs over the next 12 months, according to an analysis by WalletHub.
“It’s still a great opportunity to secure a zero percent balance transfer card,” said Greg McBride, Bankrate’s chief financial analyst. “These offers are still around, and if you have credit card debt, this is your first step in gaining momentum on your debt-payoff journey.”
2. Mortgage rates remain high
Because mortgage rates for 15- and 30-year mortgages are fixed and linked to government bond yields and the economy, homeowners will not be immediately affected by a rate hike. However, anyone buying a new home has lost significant purchasing power, in part due to inflation and the Fed’s policy actions.
According to Freddie Mac, the average interest rate on a 30-year fixed-rate mortgage is currently around 7%.
With much of the upcoming rate hike anchored in mortgage rates, homebuyers will pay about $11,160 more over the life of the loan, assuming a 30-year fixed rate, according to WalletHub’s analysis.
Other home loans are more closely linked to Fed actions. Adjustable rate mortgages (ARMs) and home equity lines of credit (HELOCs) are linked to the prime rate. Most ARMs adjust once a year, but a HELOC adjusts instantly. According to Bankrate, the average interest rate on a HELOC is already 8.58%, the highest in 22 years.
3. Car loans are becoming more expensive
Even when car loans are frozen, the payments continue to increase as the price of all cars increases and interest rates on new loans increase at the same time. So if you are planning to buy a car, you will have to spend more in the coming months.
According to Edmunds, the average interest rate on a five-year new car loan is already 7.2%, the highest in 15 years.
The double burden of unrelentingly high vehicle prices and huge borrowing costs poses major challenges for buyers.
Ivan Druri
Director of Insights at Edmunds
According to Edmunds, paying an annual percentage of 7.2% instead of last year’s 5.2% could cost consumers $2,278 more in interest over the course of a 72-month $40,000 auto loan.
“The twin burdens of unrelentingly high vehicle prices and skyrocketing borrowing costs pose significant challenges for buyers in today’s auto market,” said Ivan Drury, director of insights at Edmunds.
4. Some student loans are more expensive
Federal student loan rates are also fixed, so most borrowers are not directly affected by the Fed’s actions. But as of July, undergraduate students taking out new federal direct student loans will pay an interest rate of 5.50%, up from 4.99% in the 2022-23 academic year.
For now, anyone with existing federal education debt will benefit from 0% interest rates until student loan payments resume in October.
Personal student loans typically have a variable interest rate tied to the Libor, federal funds rate, or Treasury bill rate — meaning that if the Fed raises interest rates, these borrowers will also have to pay more interest. But how much more will vary by benchmark.
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The good news is that interest rates on savings accounts are also higher.
While the Fed has no direct influence on deposit rates, these tend to be related to changes in the target rate on federal funds. Savings account rates at some of the largest retail banks, which have been near bottoming out for most of the Covid pandemic, are now averaging as much as 0.42%.
Thanks in part to lower overheads, interest rates for the highest-yielding online savings accounts are now over 5%, the highest since the 2008 financial crisis, with some short-term certificates of deposit being even higher, according to Bankrate.
However, if this is the Fed’s last hike for a while, “you could see yields starting to come down,” McBride said. “Now is a good time to capture that.”
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