The Federal Reserve is the central bank of the United States and is charged by Congress to maintain a stable economy and financial system.
One of the ways the Fed does this is by increasing and lowering the cost of borrowing money. Interest rate cuts are intended to encourage more borrowing and spending by people and companies. That spending, in turn, tends to accelerate growth and energize economies. Lower mortgage rates, for example, typically lift home sales. And cheaper borrowing can lead businesses to take out loans and expand and hire.
Conversely, interest rate increases helps 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 one quarter of a percentage point, its first rate increase in three years, with more slated for this year times this year, and consumers and businesses will eventually feel it.
“The cumulative effect of rate hikes is what is really going to have an impact on the economy and household budgets,” Bankrate.com’s chief financial analyst Greg McBride told CNBC.
Here are some ways the Fed cut could impact your wallet:
How Fed hikes affect credit card interest rates and borrowing costs
Most credit cards have variable interest rates and those are tied to the financial institution’s prime rate, which is the rate that banks charge their more creditworthy customers. The prime rate is based on the Fed’s benchmark rate, which is the overnight rate banks charge each other to lend money in order to meet mandated reserve levels. When benchmark rates go up, 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 increase interest rates for cardholders and borrowers with variable APRs, but won’t likely offer much relief to people with large credit card balances. That’s because APRs remain high.
Credit card rates are currently around 16.34%, according to Bankrates.com. While a half point increase might not spur financial ruin for borrowers with low balances, those with larger credit debts will likely feel the impact at time when the cost of living is already surging. Annual percentage rates will also rise when the Fed makes a move.
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 charges within the introductory zero percent APR window is one way to eliminate your debt without interest.
Will the Fed increase affect mortgage rates?
The impact of the Fed rate cut on home loans depends on whether the borrower has a fixed or adjustable-rate mortgage (ARMs), and even then, only slightly. That’s because the Fed rate and mortgage rates are not directly linked.
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 pegged to yields on government bonds, especially 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 for a 30-year fixed-rate home mortgage has already risen to 4.14%, and rates are expected to climb higher for new home buyers.
Rates for fixed mortgages are also influenced by supply and demand. When business is booming for mortgage lenders, they raise rates to decrease demand. When fewer people are taking out mortgages, lenders cut rates to attract more customers.
Mortgage rates are ultimately set by the investors. Most US mortgages are packaged as securities and resold to investors. Lenders offer consumers an interest rate that third party investors are willing to pay.
Some homeowners with adjustable rate mortgages could eventually see their interest rates go up and higher monthly payments. But that depends on when their rate is scheduled to reset as ARMs only reset once a year.
What about car and student loans?
Auto loans are not expected to be impacted by the Fed rate hike because most are usually fixed-interest loans. However, lenders may increase their rates when the Fed rate changes, making new purchases a bit more expensive — but not by much.
A quarter percentage point difference on a $25,000 loan is $3 a month, Bankrate’s McBride notes.
“Nobody is going to have to downsize from the SUV to the compact because of [interest] rates going up,” he told CNBC.
As for student loans, all government-held federal student loans have been in a payment pause, with interest suspended, since March 2020 due to the coronavirus pandemic. That relief was originally scheduled to end on January 31, 2022, but in December President Joe Biden extended that relief further to May 1. Any interest rate increase by the Fed will have no impact on these loans. Additionally, Congress establishes federal student loan interest rates through legislation, which it updates periodically, and not the lenders.
But, borrowers with a private loan may have a fixed or a variable rate tied to the Libor, London InterBank Offered Rate, another key interest rate used by banks for short-term lending with other banks, according to CNBC. That means as the Fed raises rates, borrowers will likely pay more in interest, although how much more will vary by the benchmark and lender.
What about the return on my savings?
Savers won’t benefit directly from the Fed rate increase because deposits generally are slow to respond to interest rate hikes. Plus, savings account rates are at historic lows, and any minor increases won’t hold much purchasing power because of rising inflation.
The FDIC reports that the average rate paid on savings accounts in the US is a mere 0.06% for a brick-and-mortar institution. Some online lenders, however, have been competing to offer higher yield savings accounts with rates hovering around 6%, according to Bankrates.com.
Consumers who find themselves worried about an economic downturn should still take steps now to shore up their finances, regardless of rates. That includes paying down debt, refinancing at lower rates and boosting emergency savings.
The Associated Press contributed to this report.