The Federal Reserve (Fed) has hiked interest rates by another 0.75 percentage points in a bid to cool the US economy that’s reeling under heavy inflation. Consumers are already facing the brunt of the drastically increased cost of living, but the rising interest rates present their own opportunities and barriers.
If you’re already reeling under the high cost of living thanks to the sky-high inflation rate gripping the United States at the moment, increasing interest rates present both barriers as well as opportunities. Let’s look at what the increasing federal rates mean for you and how they will impact you.
Federal funds rates: what they mean to you
The central bank of the United States sets the federal funds rate. This rate is the interest rate at which banks lend and borrow money to and from each other overnight. Consumers don’t pay this rate, but every move the Fed makes impacts savings and borrowing rates they encounter every day. For example, the recent increase in interest rate will result in an increase in the prime lending rate. This will immediately increase financing costs for various types of borrowing and loan products for consumers. On the other hand, a higher interest rate also means that people with savings accounts will earn more money on the money they deposit.
How higher interest rates affect borrowers
When Fed funds rate increases, the first loan product that will show a rise in interest rates is short-term borrowings. This includes credit cards and lines of credit taken on home equity. Most credit cards don’t have a fixed rate of interest. Their varying rate is pegged to the prime rate. When the Fed rate goes up, so does the prime rate. Hence, credit cards will also increase their interest rates.
The average annual percentage rate (APR) for credit cards right now is just a little above 17%. According to expectations, this can go up to an all-time high of 19% by the time the year ends. If you’re someone with an outstanding balance on your credit cards, make sure you pay off the dues right away. Otherwise, you may end up paying a lot more interest soon.
For borrowers, the best thing to do is to start paying off more debt, if possible, right away. Try and close your outstanding debts at the earliest so that the higher interest payments don’t ruin your finances. You can reduce your interest payments by consolidating your debts into one loan with a lower interest rate. Debt consolidation is a great way to eliminate multiple loans with varying interest rates. 0% balance transfer is also another good option.
If you’re in the market to buy a new home, you might hear that your purchasing power has been severely impacted. Adjustable mortgage rates have gone up by almost double what they were at the start of 2022.
What hasn’t changed
When it comes to auto loans, if you’ve already bought a vehicle, your interest payments will not be affected since auto loan interest rates are fixed. However, if you’re looking to buy a vehicle now, you may have to shell out a lot more money. This is due to two reasons. One, the prices of cars have considerably increased. Two, the new interest rates on auto loans are much higher than before.
The same logic applies to student loans as well. Federal student loans have a fixed rate of interest. So if you’re already repaying a loan, your interest rate will not change. However, if you’re applying for a new federal student loan, your interest rate will now be 4.99% rather than the 3.76% that it was last year.
For private loans, the new rate you have to pay depends on whether your interest rate is variable or not. When the Fed rate increases, you will also likely pay higher if your interest rate is variable or flexible.
How higher interest rates affect savers
Due to consecutive Fed rate hikes, the good that has come out of it is that the interest rates on savings accounts are now higher than they were before. Although the Fed rate does not directly impact bank account deposit rates, there is a correlation between bank rates and changes in the target federal funds rate. Due to the recent rate hikes, the savings account rates offered by some of the largest retail banks are now at an average of 0.10%. These rates were almost at negligible levels about 2 years ago.
Leading online savings banks are offering much higher rates on their high-yield savings accounts, as much as 1.75% to 2%. This is mainly due to the lower overhead expenses incurred by online banks when compared to traditional, brick-and-mortar banks. If the central bank continues to increase the rates, these bank savings rates will continue to increase as well. However, keep in mind that when inflation is high, your purchasing power reduces. So, any extra interest you earn may not even cover the increase in the cost of goods.
What the road ahead looks like
Since the Fed has indicated that more interest rate hikes are on the way, consumers should be prepared for that. The benchmark Fed funds rate is now the same as it was back in July 2019. But since the inflation rate is still more than 9%, we are nowhere close to the end of rate hikes. The Federal Reserve is expected to increase its rates again multiple times in the coming months, mostly in September, November and December. It is possible that the rates will be cut in the spring, based on how the economic situation is then.