Federal Reserve: What the rate hike means

Image commercially licensed from DepositPhotos
Image commercially licensed from DepositPhotos

At the end of its two-day meeting on Wednesday, the Federal Reserve raised its target federal funds rate by 0.5 percentage points. This was done to try to keep inflation down.

Greg McBride, the chief financial analyst at Bankrate.com, says that even though this is a smaller increase than the 0.75 percentage point jumps at each of the last four meetings, the Federal Reserve is far from done.

The latest move is just one part of a cycle of raising interest rates. The goal is to lower inflation without sending the economy into a recession, which some people thought would have happened already.

Still, the combination of higher interest rates and inflation has made it very hard on household budgets.

What you need to know about the Federal Reserve rate

The federal reserve rate is the interest rate banks use to borrow and lend money to each other overnight. The central bank sets it. Higher Fed rates affect how much it costs consumers to borrow money and, to a lesser extent, how much they can earn in their savings accounts.

For now, this puts a lot of Americans in a tough spot because inflation and rising prices are making more people rely on credit while interest rates are going up faster than they have in decades.

With more economic uncertainty on the horizon, McBride suggested that consumers take specific steps to stabilize their finances, such as paying down debt, especially expensive credit card debt and other debt with variable interest rates, and saving more.

Pay off your high-interest debt

Since the interest rate on most credit cards is variable, there is a direct link to the Federal reserve benchmark, which means that short-term borrowing rates are already going up.

Bankrate says that the average APR for a credit card is now over 19%, up from 16.3% at the beginning of the year.

Since 15-year and 30-year mortgage rates are fixed and tied to Treasury yields and the economy, a rate hike won’t affect those homeowners immediately.

But this week, the average interest rate for a 30-year fixed-rate mortgage is around 6.33%, more than three full percentage points higher than a year ago, when it was only 3.11%.

People who want to buy a new car with a loan will also have to pay more in the coming months. Even though payments on auto loans are fixed, they are getting more expensive because interest rates are rising.

According to data from Edmunds, the average monthly payment went up to over $700 in November, up from $657 earlier in the year. This is even though the average amount financed and average loan terms stayed about the same.

Rates for federal student loans are also fixed, so a rise in rates won’t affect most borrowers right away. But if you have a private loan, the rate may be fixed or tied to the Libor, prime, or T-bill rates, which means that as the Fed raises rates, borrowers will likely pay more in interest, though how much more will depend on the benchmark.

Because of this, now is a great time to look at the loans you still have to see if refinancing makes sense.

Look around for better savings rates

Even though the Fed doesn’t have direct control over deposit rates, they tend to be linked to changes in the target federal funds rate. So, for example, savings account rates at some of the biggest retail banks, which were very low during most of the Covid pandemic, are now up to an average of 0.24%.

The average rate for an online savings account is around 4%, much higher than that for a traditional, brick-and-mortar bank. This is because online banks have lower overhead costs.

McBride said, “The good news is that savers are getting the best returns in 14 years if they shop around.”

Top-yielding certificates of deposit, which pay between 4% and 5%, are even better than high-yield savings accounts.

But because the inflation rate is now higher than all of these rates, any money saved over time loses its ability to buy things.

What next for the Federal Reserve?

In the next few months, interest rates will likely increase.

Even though the Fed has already raised rates seven times this year, more increases are coming as the central bank works to slow inflation down.

Read Also: Wage growth: Private sector sees all-time high

Recent data, like a consumer prices, report for November that was better than expected, show that these changes are starting to work. But inflation is still well above the Fed’s goal of 2%.