the Federal Reserve is the central bank of the United States and is charged by Congress with maintaining a stable economy and financial system.
One of the ways the Fed does this is to raise and lower the cost of borrowing money. The interest rate cuts are intended to encourage borrowing and spending by individuals and businesses. This spending, in turn, tends to accelerate growth and energize economies. Lower mortgage rates, for example, typically boost home sales. And cheaper borrowing can encourage businesses to take out loans, grow and hire.
Conversely, interest rate hikes help contain inflation, as consumers spend less when the cost of borrowing rises.
The Fed is expected to raise its benchmark interest rate this week by a quarter of a percentage point, its first rate hike in three years, with more expected this year this year, and consumers and businesses will eventually to feel.
“The cumulative effect of rate hikes is what’s really going to impact the economy and household budgets,” said Greg McBride, chief financial analyst at Bankrate.com. CNBC.
Here are some ways the Fed cut could impact your portfolio:
How Fed Hikes Affect Credit Card Interest Rates and Borrowing Costs
Most credit cards have variable interest rates and these are tied to the financial institution’s prime rate, which is the rate banks charge their most creditworthy customers. The prime rate is based on the Fed’s benchmark rate, which is the overnight rate that banks charge each other to lend money to meet reserve requirement levels. When benchmark rates rise, it becomes more expensive for banks to borrow money, and they pass those costs on to consumers in the form of higher interest rates on lines of credit.
A rate hike would raise interest rates for cardholders and borrowers with varying APRs, but likely wouldn’t offer much relief to people with large credit card balances. This is because the APRs remain high.
Credit card rates are currently around 16.34%, according to Bankrates.com. While a half-point hike won’t cause financial ruin for borrowers with low balances, those with larger credit debts will likely feel the impact when the cost of living is already rising. . Annual percentage rates will also rise when the Fed acts.
Bankrate.com advises consumers to consider balance transfer card options to pay off their credit card debt. Finding a card that offers zero percent interest on balance transfers and paying off your fees within the zero percent introductory APR window is one way to eliminate your interest-free debt.
Will the Fed hike affect mortgage rates?
The impact of the Fed’s rate cut on home loans depends on whether the borrower has a fixed or adjustable rate mortgage (ARM), and even then only slightly. This is because the Fed rate and mortgage rates are not directly related.
A home loan is a long-term financial product, the most common being a 30-year fixed rate mortgage, while the Fed rate is for short-term overnight borrowing. Long-term mortgage rates are indexed to government bond yields, in particular the 10-year Treasury note, according to CNBC.com. When that rate goes up, the popular 30-year fixed rate mortgage tends to do the same.
Still, the average 30-year fixed rate mortgage has already reached 4.14%, and rates are expected to climb higher for new home buyers.
Fixed mortgage rates are also influenced by supply and demand. When business is booming for mortgage lenders, they raise rates to reduce demand. When fewer people take out mortgages, lenders cut rates to attract more customers.
Mortgage rates are ultimately set by investors. Most US mortgages are presented in the form of securities and resold to investors. Lenders offer consumers an interest rate that third-party investors are willing to pay.
Some homeowners with variable rate mortgages could eventually see their interest rates increase and their monthly payments higher. But it depends on when their rate needs to reset, as ARMs only reset once a year.
What about car and student loans?
Auto loans should not be affected by the Fed’s rate hike, as most are generally fixed rate loans. However, lenders can raise their rates when the Fed rate changes, making new purchases a bit more expensive — but not much.
A quarter-percentage-point difference on a $25,000 loan works out to $3 a month, Bankrate’s McBride notes.
“Nobody will have to go from SUV to compact because of [interest] rates are going up,” he told CNBC.
With respect to student loans, all federal student loans held by the government have been on payment pause, with interest suspended, since March 2020 due to the coronavirus pandemic. This relief was originally scheduled to end on January 31, 2022, but in December President Joe Biden extended this relief until May 1. Any increase in interest rates by the Fed will have no impact on these loans. Additionally, Congress sets federal student loan interest rates through legislation, which it updates periodically, not through lenders.
But, borrowers with a private loan can have a fixed rate or a variable rate linked to the LiborLondon InterBank Offered Rate, another key interest rate used by banks for short-term loans with other banks, according to CNBC. This means that as the Fed raises rates, borrowers will likely pay more interest, although the amount will vary depending on the benchmark and the lender.
What about the return on my savings?
Savers will not directly benefit from the Fed’s rate hike because deposits are generally slow to react to interest rate hikes. Additionally, savings account rates are at historic lows and any minor increases won’t hold much purchasing power due to rising inflation.
FDIC reports that the average rate paid on savings accounts in the United States is a simple 0.06% for a brick and mortar institution. Some online lenders, however, compete to offer higher-yielding savings accounts. with rates hovering around 6%according to Bankrates.com.
Consumers worried about an economic downturn should still take steps now to shore up their finances, regardless of rates. This includes paying off debt, refinancing at lower rates, and increasing emergency savings.
The Associated Press contributed to this report.