On June 13, the Federal Reserve raised the federal funds rate to a range of 1.75% to 2%—a benchmark not seen since 2008. For the past decade, U.S. consumers have lived in a world of historically low interest rates, which are echoed in cheaper mortgage interest rates and low yields on savings accounts.
According to a Wall Street Journal survey, economists expect interest rates to climb higher later this year, and consumers now have to face the prospect that increased interest rates have not only returned—they may be here for a while. The question on most consumers' minds: How does the Fed rate affect me?
1. Mortgage Rates
Perhaps the most obvious difference in higher versus lower interest rates is with home mortgages. A decade's worth of low interest rates has generally been favorable to anyone buying a new home.
This has reduced the overall cost of acquiring a home loan, which in turn has made it more affordable for people of different income ranges to secure a house.
Rising interest rates can be good for those with fixed-rate mortgages because it means they were able to lock in a low interest rate at an opportune time. For those with adjustable-rate mortgages, rising interest rates might become worrisome, as they can lead to higher mortgage payments.
According to data from the St. Louis Federal Reserve, the average rate for a 5/1-year adjustable-rate mortgage bottomed out at around 2.5% in 2013, and it has risen steadily to approach 4%.
Homeowners with adjustable-rate mortgages need to consider the possibility of rising homeownership costs, as the Federal Reserve has indicated it will keep raising interest rates.
2. Savings Accounts
Interest rates can manipulate the way people save or spend money, which influences the flow of cash throughout the U.S.
When interest rates are low, the balances on savings accounts across the country tend to remain low as well. This is due to the increased incentive for consumers to either spend or invest their money rather than keep it stored in savings accounts with low interest rates.
We've seen that effect captured in the data. According to a 2017 GOBankingRates survey, some 57% of Americans reported having less than $1,000 stored in savings.
But as interest rates rise, it slowly becomes more profitable to move money into savings.
This is great news for those with substantial money put aside in savings accounts earmarked for emergencies. When interest rates are high enough, the money in savings accounts can even beat inflation.
3. Credit Card Rates
Credit cards are not exempt from the effects of interest rate hikes from the Fed. When banks raise their "prime rate," it affects many consumer rates—including interest on credit cards. As interest rates rise, it's a good idea to pay off any outstanding credit card debt.
Those who carry a balance on a card with an introductory rate should read the fine print in their credit card agreements to make sure they're not caught off guard when the interest rates do kick in.
Putting off credit card debt can reduce financial pressure in the short term, but as interest rates rise, it will only become more difficult to pay off credit card debt.
While it's possible to see interest rate hikes coming in advance — particularly given the sentiment expressed in The Wall Street Journal survey — credit card consumers who still carry outstanding balances on their cards should pay attention to rising rates to avoid finding themselves with higher payments down the line.
4. Other Loans
Auto loans and home equity lines of credit may also see higher interest rates as a result of Fed rate hikes, according to David Wheelock, vice president of the St. Louis Fed, told the site: "If the federal funds rate is falling, then in some sense, the cost of funds for the bank is falling."
Banks then pass on the savings to their customers. However, with higher interest rates, the opposite can be true — higher interest rates mean higher costs of funds, which banks will also pass down to consumers in the form of higher rates on everything ranging from auto loans to home equity lines of credit, or HELOCs.
How should most consumers prepare for higher interest rates? Here are a few things to consider:
- Clear debt. Holding debt means paying interest rates to the lender. Clearing debt will ensure that the consumer doesn't have to pay higher interest rates.
- Get a fixed-rate mortgage. While fixed-rate mortgages tend to be more expensive, they also "lock in" interest rates while they're still low—which can be a tremendous advantage for homeowners if rates continue to increase.
- Put money in savings. Increasing your personal rate of savings will allow you to take advantage of higher interest rates and create a financial buffer against unforeseen circumstances.
No one knows what the economy has in store, but Wall Street does tend to have an accurate view of whether the Fed rate will increase.
For the time being, it appears the rate is headed upward — which means that consumers should start preparing now.
Joe Resendiz is a Research Analyst at ValuePenguin, where he focuses on personal finance and credit research to assist consumers. Previously, Joe specialized on public sector and infrastructure financing at Goldman Sachs. He graduated from the University of Texas at Austin with a BBA in Finance.
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