Interest — This week, the Federal Reserve continued its efforts to slow down inflation, raising the target federal funds rate by a quarter of a point. The decision saw the central bank’s Federal Open Market Committee raise the rate to a target range between 5.25% and 5.5%. As a result, the midpoint of the target hits the highest level for the benchmark rate since 2001.
In the last meeting, holding rates were held steady, and the central bank indicated that the efforts to bring price increases down is still far from over even with recent signs saying inflationary pressures have cooled down.
As of now, inflation is still higher than the Fed target of 2%. However, Columbia Business School economics professor Brett House said, “It’s entirely possible that this could be the last hike in the cycle.”
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Federal fund rates
The US central bank is responsible for setting up the federal funds rate, which is the interest rate banks borrow and lend one another overnight. While the federal funds rate isn’t the rate consumers pay, decisions made by the Fed usually affect the borrowing and saving rates consumers see on a daily basis.
The recent hike in interest rates marks the 11th time the Federal Reserve has raised interest rates, the first being March 2022. It also corresponds to the rise in prime rate and immediately sends financing costs higher for many forms of consumer borrowing. As a result, it adds more pressure on households in hope of avoiding a possible recession.
“The pain that the rate hike has caused for a lot of people isn’t gratuitous,” said House.
“Ultimately, this is a trade off in choices between pain now and greater pain later if inflation isn’t brought under control.”
How the higher interest rates affect you
Mortgage rates remain high
Homeowners won’t be immediately affected by the interest rate hike due to 15- and 30-year mortgage rates getting fixed and tied to Treasury yields and the economy. However, the inflation and Fed’s policy decisions also keeps people from shopping for new homes. Freddie Mac reported that the average rate for a 30-year, fixed rate mortgage is currently around 7%.
As the coming rates will be implemented into mortgage rates, homebuyers will have to pay $11,160 more over the duration of the loan. Meanwhile, other home loans are more closely tied to the Fed’s actions.
Adjustable-rate mortgages and home equity lines of credit are linked to the prime rates. While most ARMs adjust once a year, a HELOC adjusts immediately. Bankrate reported that the average rate for a HELOC is already up to 5.8%, the highest in 22 years.
Student loans shoot up
Federal student loan rates are fixed, which means that most borrowers won’t be immediately affected by the hikes. However, as of July, undergraduate students taking out new direct federal student loans will have to pay an interest rate of 5.50% in the 2022-2023 academic year.
Anyone who has an existing federal education debt for now will benefit from rates at 0%, but student loan payments will restart in October.
Private student loans usually have a variable rate tied to the Libor, which means that as the Fed raises rates, borrowers will also pay more in interest.
Car loans become harder to attain
Auto loans may be fixed, but payments are also getting bigger due to the price for cars rising in tandem with the interest rate on new loans.
Edmunds reported that the average rate on a five-year new car loan is already at its highest in 15 years, sitting at 7.2%. Paying an annual percentage rate of 7.2% instead of 2022’s 5.2% could lead to consumers paying $2,278 more in interest throughout the $40,000, 72-month car loan.
“The double whammy of relentlessly high vehicle pricing and daunting borrowing cost is presenting significant challenges for shoppers in today’s car market,” said Edmunds’ director of insights Ivan Drury.
Credit cards reach record highs
As credit cards have a variable rate, they have direct connections to the Federal Reserve’s benchmark. When the federal funds rate rises, the prime rate also rises, with credit card rates following within one or two billing cycles.
The average credit card rates have hit an all-time high, going up by more than 20%. Meanwhile, balances are higher and nearly half of all credit card holders have debt from month to month.
“It’s still a tremendous opportunity to grab a zero percent balance transfer card,” said Bankrate chief financial analyst Greg McBride.
“Those offers are still out there, and you have credit card debt, that is your first step to give yourself a tailwind on a path to debt repayment.”
A silver lining
While it might seem as if it’s all downsides, there are also silver linings, such as interest rates on savings accounts going higher.
Although the Federal Reserve doesn’t directly influence deposit rates, they are usually correlated with changes in the target federal fund rates. During Covid, the savings account rate in some of the largest retail banks hit near rock bottom. However, they are currently up to 0.42% on average.
Due to lower overhead expenses, top-yielding online savings accounts rates are now over 5%, the highest since the 2008 financial crisis.
However, McBride warned that if this is the Federal Reserve’s last increase for some time, yields could slip eventually.
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