Consumer borrowing costs are headed higher.
The Federal Reserve raised its key short-term interest rate by a quarter percentage point Wednesday, and Americans will soon see higher rates on everything from credit cards to mortgages.
The good news: Consumers will finally see rates rise from measly levels on at least some bank savings accounts and CDs.
The first increase of the federal funds rate in more than three years will kick off six such moves this year, top economists say, as the central bank sets out to corral inflation that reached a 40-year high of 7.9% in February.
Keep in mind that this rate – which is what banks charge each other for overnight loans – is near zero. That means borrowing costs are at rock bottom and will still be historically low even if the Fed makes good on economists’ forecasts.
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How much will the Fed raise interest rates?
The seven total quarter-point increases the Fed forecast Wednesday mark its most aggressive hiking campaign since 2005 and would leave its key rate at a range of 1.75% to 2% by year-end. Another four hikes are projected in 2023, a blueprint that would push the rate to 2.8% by the close of that year.
“Now is a good time to try to pay off debt to protect yourself from rising rates, as well as to lock in fixed rates on any new loans you might need, such as a mortgage or auto loan,” says Kimberly Palmer, a personal finance expert at NerdWallet.
The difference between the upcoming rate increases and the Fed’s last cycle, from 2015 to 2018, is that Americans are already struggling with soaring prices. During the last round, inflation was around or below the Fed’s 2% annual target. Although the rate increases are intended to slow economic growth and subdue inflation, that won’t happen right away.
As a result, consumers grappling with high prices of gasoline, groceries and rent, face yet another climbing expense.
“Rising interest rates will just be another form of inflation,” says Greg McBride, chief economist of Bankrate.com.
How do rising interest rates affect consumers?
Wednesday’s bump will have the biggest near-term effects on credit cards, adjustable-rate mortgages and home equity lines of credit. All are revolving loans with variable rates that are directly affected by Fed moves.
Americans with 30-year mortgages will feel the impact, though much of this year’s projected increases are already figured into mortgage rates. Car buyers will be affected – but by just a modest rise in monthly payments.
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Here’s how to break down the impact of the Fed’s move:
How does Fed interest rate affect credit cards, adjustable-rate mortgages, HELOCs?
These loans will become more expensive within one or two months since they are tied to the prime rate, which in turn is linked to the Fed’s benchmark rate. In other words, a Fed quarter-point increase is largely passed on.
Credit card rates average 16.34%, according to Bankrate.com. For a $5,000 credit card balance, a quarter-point hike probably will add $187 in total interest for borrowers who make the minimum monthly payment, McBride says.
Sara Rathner, a credit card expert at NerdWallet, says it’s a good time to pay down credit card debt. Consumers with good credit may qualify for a balance transfer card that charges zero interest for a year or more, “allowing you to lock in the savings while you pay off your balance,” Rathner says. Consolidating debts into a personal loan with a lower fixed monthly rate is also a good option, she says.
The average rate for a home equity line of credit (HELOC) is 3.96%, McBride says. A quarter-point increase on a $30,000 credit line raises the minimum monthly payment by $6, he says. Five such bumps would result in a $30 increase in your monthly tab.
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By contrast, adjustable-rate mortgages are modified once a year after the fixed-rate period ends, typically after five years. The impact thus will be delayed, but then it could bite. Five quarter-point hikes over 12 months would increase the monthly payment on a $300,000 adjustable mortgage by $187.
How does Fed interest rate affect fixed-rate mortgages?
Thirty-year fixed-rate mortgages trace movements in the 10-year Treasury note and are affected by the Fed’s key short-term rate only indirectly.
The average 30-year fixed rate is at 3.85%, according to Freddie Mac, up nearly a percentage point since November. That has raised the typical payment on a $300,000 mortgage by $145 to $1,719, according to Bankrate’s mortgage calculator.
Though some of the increase is due to anticipation of one or two Fed hikes, the rate also rises in response to higher inflation and an improved economic outlook, says Jacob Channel, senior economist at LendingTree.
“It’s not a one-to-one relationship,” he says.
Steve Rick, chief economist of CUNA Mutual Group, says, “The more the (Russia-Ukraine) war intensifies, the lower the 10-year Treasury” and mortgage rates, could go. For example, the average 30-year rate has dipped from 3.92% since mid-February on developments in Ukraine, he says. That’s because rates go down as bond prices rise, which is happening as investors buy safe-haven bonds.
McBride says about four Fed rate increases are already priced into average mortgage rates. Channel says several more hikes this year probably would push mortgage rates above 4%. That could add $60 or so to the average mortgage payment, beyond the $145 increase since fall.
How does Fed interest rate affect auto loans?
A quarter-point Fed rate increase should filter through to new auto loans, but the toll shouldn’t be significant. The monthly payment for a new $25,000 car would rise by about $3 a month, McBride says. Car loan rates average 3.98%, he says.
Since car prices have risen 12.4% the past year on supply chain troubles, “the bigger question is, can you find a car in your price range?” McBride says.
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How does Fed rate affect bank savings?
As Fed rates rise, banks will be able to charge a little more for loans, giving them more profit margin to pay a higher rate on customer deposits.
Don’t expect a fast or equivalent rise on most savings account and CD rates, says Ken Tumin, founder of DepositAccounts.com.
Since the pandemic, “banks have a record amount of deposits,” and the demand for loans has been weak because of the COVID-19-related downturn, Tumin says. In other words, they’re not clamoring for your money.
The average savings rate is a minuscule 0.06%, and the average one-year CD is at 0.14%, Tumin says. Those probably won’t budge much after the Fed hikes Wednesday.
Online banks are a different story. They have lower costs and face more intense competition since consumers can more easily transfer their money from one online bank to another, Tumin says.
The average online savings rate has risen to 0.49% from about 0.45% since late last year in anticipation of higher Fed rates. The typical online one-year CD has crept up to 0.67% from 0.57%, Tumin says.
Tumin says online rates could mirror the Fed’s move in a couple of months, though McBride says the banks will likely stop a bit short of a full quarter-point increase.
Follow Paul Davidson on Twitter at @PDavidsonusat
This article originally appeared on USA TODAY: Interest rate increase: How Fed hike will affect your wallet, finances