Fed interest rate hike: Who should care — and 5 more answers on how higher rates affect your money
The Federal Reserve is at it again, announcing Wednesday that economic conditions are strong enough to warrant adding another 0.25% to the federal funds rate, which in turn affects the cost of borrowing money nationwide.
“Economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong,” the Fed release states. “Inflation... is expected to move up in coming months and to stabilize around the... 2% objective over the medium term.”
Now, if that news doesn’t mean much to you, you are not alone. In fact, many people aren’t even aware of the bank’s moves, NerdWallet analyst Holden Lewis said in an email. “In a recent NerdWallet survey, 62% of respondents said they didn’t know the Fed raised rates last year,” he said.
But sleeping on Federal Reserve news can mean missing out on both financial opportunity and potential pitfalls. “If you have credit cards or a [home equity line of credit], every Fed rate hike affects your bottom line,” Lewis said.
Who else should be paying attention and why? Here are your five biggest questions about the Fed and the new rate hike, answered.
1. Why is the Fed raising rates? How does monetary policy and the “dual mandate” affect me?
To understand why this is happening, it helps to look at monetary policy, which is how the central bank controls money supply and interest rates — primarily by buying or selling government bonds (aka quantitative easing and tightening) and adjusting banks’ reserve requirements.
What’s the point of this? The Fed has to follow a challenging “dual mandate,” which is a two-fold responsibility to keep price inflation rising at a healthy, slow rate, but also to maximize employment. The bank tries to achieve this tricky feat by carefully raising and lowering the federal funds rate, which influences the interest rates consumers pay for (and earn from) different financial products.
Those who could feel the effects include student borrowers, those looking to buy cars or homes, retirement investors, business owners and essentially anyone with a savings account.
Think of the funds rate as the knob on your air conditioner that controls intensity: When the central bank keeps interest rates very low and thus it stays cheaper to borrow, people spend more and business hire more — meaning the economy is able to “heat up” quickly.
On the other hand, if conditions start to get too “hot” — meaning an economic recovery is starting to cause price inflation and too much risky speculation — the Fed can turn the knob by raising the funds rate, “cooling off” conditions.
The danger? Timing interest rate hikes is a very delicate balancing act. Go too fast, and you could halt economic growth — or at least rock the stock market, which happened in February when strong economic data increased expectations of four rate hikes in 2018 instead of the three previously expected.
Stock market observers paid close attention to the tone of new Fed chairman Jerome Powell’s press conference Wednesday. Investors were particularly interested in whether the bank would raise rates three or four times in 2018: While the Fed forecasted the possibility of additional hikes in 2019 and 2020, it maintained the same three-hike projection for the rest of the year, as MarketWatch reported.
Both the Dow Jones Industrial Average and S&P 500 closed 0.18% lower for the day. On one hand, that’s not bad relative to other historic market performance after a new Fed chair’s first major conference, according to data shared on Twitter by StockTwits. But uncertainty still looms: Powell said some members of the Federal Open Markets Committee have voiced concerns about the possibility of a trade war — and its potential to spook investors.
2. What is the interest rate now? How will that affect me in the short and long term?
As expected, the Fed raised the federal funds rate to a range between 1.5% and 1.75%. That brings the effective rate to about 1.63%, the highest it has been since the early parts of the financial crisis in 2008, as Yahoo reported.
Other than the obvious immediate effects on the stock market, in the short term, a rate hike means credit card APRs will rise — an effect that usually happens within a month, according to CreditCards.com.
Over the longer term, savings account and interest checking rates will also increase — helping savers — though car loans, home equity loans and possibly even the cost of mortgages will also tick up, squeezing borrowers.
If companies also feel tighter because of higher borrowing costs and lower consumer spending, employers might become less willing over the long term to create new jobs, making it trickier to find new work or ask for a raise. That’s why some critics of the Fed have argued against raising interest rates until there is more evidence of rising wages.
3. Will savings account interest rates change — and how do I get the best deal?
First up, the good news: When the Fed raises interest rates, it’s usually a positive change for savers, who can expect to see slightly better returns on their savings accounts.
For the last five rate hikes, banks have been dragging their feet when it comes to passing the extra interest onto their customers, though that’s expected to change, according to the Wall Street Journal. Earlier this month, the average interest rate on certificates of deposit rose the fastest it had in seven years.
Historically, savers in money market and interest checking accounts have seen higher interest between eight and 14 months after a rate hike, Money has reported.
Want to capture some upside yourself? Higher-paying savings accounts have been easier to come by from online banks, Ken Tumin of DepositAccounts noted in an email: In fact, online banks have raised their interest rates three times more than brick-and-mortar counterparts since the start of 2017, he said.
4. What will happen to average annual credit card interest rates?
A downside of higher interest rates for a lot of consumers is going to be the higher APRs on consumer debt like credit cards.
On an individual level, the impact is relatively small: As a result of today’s rate hike, someone with a balance of about $10,000 might pay an extra $150 or so in charges, according to calculations by MarketWatch. The total impact of a hike on credit card users will be an extra $1.6 billion in finance charges, WalletHub estimates.
Alas, there’s evidence that Americans are already taking on too much credit card debt: WalletHub also estimates that consumers racked up more than $92 billion in new credit card debt last year, double the post-recession average.
But the biggest warning sign about credit cards? The charge-off rate — which is when banks write off credit card debt they don’t expect to be repaid — hit 7.2% for small banks this year, up from 4.5% last year. As the Wall Street Journal reports, that’s a possible warning sign about the financial challenges low and middle-income households are increasingly facing.
In other words, the case is stronger than ever for paying off your credit card debt quickly. Same goes for any other variable rate consumer loans you have, from personal and car loans to any outstanding debts you might have with a student loan financer.
5. What should mortgage or home loan seekers do?
A final concern for consumers? If you’re thinking about buying a home, today’s announcement could make a tough real estate hunt even tougher. As Bloomberg recently reported, the market for starter homes is getting “scarcer, pricier, smaller and more run-down.”
With the Fed continuing to raise interest rates, the cost of getting a mortgage is also going to continue climbing — Bankrate noted a slight increase in the average rates for both 15-year and 30-year mortgages on Wednesday morning ahead of the Fed’s announcement.
That said, mortgages are still historically affordable, making a good case for shopping around and locking in a rate sooner rather than later if you’re ready to buy a home. Procrastination is not your friend.
March 21, 2018: 7:45 p.m. Eastern: This story has been updated.
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