Here’s what the Fed’s rate hike means for borrowers and savers

The Federal Reserve hiked interest rates by a quarter of a percentage point from near zero at the end of its two-day meeting on Wednesday.

The first rate hike in three years will set the stage for six more hikes before the end of the year.

“The war in Eastern Europe is causing the Fed to act more cautiously, but it will continue to work to contain inflation, which is already at its highest level in 40 years,” said Greg McBride, chief financial analyst at Bankrate.com.

How the Federal Funds Rate Affects 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.

“A single quarter-point rate hike from near zero will have minimal impact on household finances,” noted McBride. However, this is just the beginning, he added.

“The cumulative effect of rate hikes will really impact the economy and household budgets.”

Loans are getting more expensive

Fixed for the long term Mortgage interest rates are already rising slightly as they are influenced by the economy and inflation.

According to Jacob Channel, senior economic analyst at LendingTree, the average 30-year fixed-rate home mortgage is now over 4% and likely to continue to rise.

  • A $300,000 fixed rate mortgage with a 30-year term would cost you about $1,432 a month at a 4% interest rate. If you paid 4.5% instead, the same loan would cost $131 more per month or an additional $1,572 per year and $47,160 over the life of the loan.

Many homeowners with adjustable rate mortgages or home equity lines of credit tied to the prime rate will be more directly affected. Most ARMs adjust once a year, while a home equity line of credit, or HELOC, adjusts immediately.

Anyone with an adjustable-rate loan may want to convert it to a fixed-rate loan now, said Mark Scribner, Boston-based chief executive of Oxygen Financial. “Perhaps there is no other opportunity.”

Short-term lending rates, especially for credit cards, will also rise quickly.

Since most credit cards have a variable interest rate, there’s a direct link to the Fed’s benchmark, so expect your APR to increase within a billing cycle or two.

  • If you owe $5,000 If you use a credit card with an APR of 19% and put $250 a month on the balance, it will take 25 months to pay you back and cost you $1,060 in interest charges. If the APR goes up to 20%, you’ll pay an additional $73 in interest.

“A quarter-point rate hike is unlikely to turn cardholder finances upside down. However, all rate hikes, even small ones, are unwelcome news for people with credit card debt,” said Matt Schulz, Leihbaum’s chief credit analyst.

Borrowers could call their card issuer and ask for a lower interest rate, switch to an interest-free credit card with a balance transfer, or consolidate and pay off high-yield credit cards with a low-interest personal loan, Schulz advised.

Even when car loans are fixed, the payments keep getting bigger because the prices of all cars go up. So if you are planning to finance a new car, you will spend more in the coming year.

According to Experian, car buyers who took out credit for a new vehicle borrowed an average of $39,721 in 2021, an increase of over $4,000 from the previous year. As a result, monthly loan payments hit a record high of $644.

  • A quarter percentage point difference on a $40,000 loan equates to about $5 per month, or another $300 over the life of a five-year loan.

Still, the Fed’s rate hike probably won’t have a significant impact on what rate you get, Bankrate’s McBride said. “No one will have to downsize from SUV to compact because of interest rates.”

Federal student loan rates are also fixed, so most borrowers are not immediately affected by a rate hike. However, if you have a personal loan, those loans can be fixed or have a floating rate tied to Libor, Prime, or T-Bill interest rates — meaning borrowers are likely to pay more interest when the Fed hiked rates, although how much more will vary by benchmark.

So this is a particularly good time to identify your outstanding loans and see if refinancing makes sense here, too.

Savers get better returns

While the Fed has no direct control over deposit rates; they tend to correlate with changes in the target overnight interest rate. As a result, the savings account rate at some of the largest retail banks is near the bottom and is currently averaging just 0.06%.

Even if the Fed starts raising interest rates, deposit rates will react much more slowly.

“Many banks aren’t going to pass higher rates on to savers, so where you park your money is going to really matter,” McBride said.

More from Personal Finance:
Why the Fed is raising interest rates to fight inflation
Inflation costs households $300 more a month
How Americans can cut costs amid record inflation

Thanks in part to lower overheads, the average online savings account rate is at least three times higher than the average rate at a traditional bank.

  • If you have $10,000 in a regular savings account, earn 0.06%, earn only $6 in interest in a year. For an average online savings account paying 0.46%, you could make $46, while a five-year certificate of deposit could bring in nearly twice that, according to DepositAccounts.com.

However, since the inflation rate is now higher than any of these rates, any savings lose purchasing power over time.

Look for other options with better prices, advised Yiming Ma, an assistant professor of finance at Columbia University Business School, such as money market funds, bond mutual funds, or exchange-traded bond funds.

There are alternatives out there that require higher risk but come with increasing returns, she said — as long as you have some shielding from recent market volatility.

“Keep enough cash aside to cover daily expenses to protect you from the big ups and downs,” Ma said. “The rest can be invested in something that can generate a good return over the long term.”

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