How Consumers Will Be Affected When the Fed Raises Interest Rates
Credit card, auto loan, mortgage rates will rise, but so will returns on savings accounts
You probably know by now that the Federal Reserve (known as the Fed) is expected to raise short-term interest rates this week. What you may not know is how this increase could affect you.
The short answer is that the interest rates on credit cards, auto loans, home equity loans, and mortgages will go up, but so will consumers' returns on savings accounts.
Bankrate Chief Financial Analyst Greg McBride said that the increase "will be a direct pass-through to credit card holders," describing it as "a rising tide that lifts all boats, and you're going to feel it in equal magnitude wherever you sit on the credit spectrum."
According to McBride, the costs for credit cards are connected directly to the prime rate, which is the interest rate that commercial banks charge their most credit-worthy customers. This rate is tied to the federal funds rate. It is the latter that the Fed is set to raise.
The adjustable annual interest rate for credit cards will rise as the prime rate and the federal funds rate go up.
The Fed is not expected to raise the rates more than a quarter-point, which will leave borrowing costs for the short term still close to historically low levels. However, since credit card debt is so much more expensive than debts like mortgages or car loans, even such a small increase will likely make consumers' lives even harder.
Although experts advise consumers to pay off their credit card balances in full each month, about 40 percent do not do so. This group of consumers already has a typical balance of almost $17,000, a figure that will only go up when interest rates rise.
Mortgages and Home Equity Loans
Mortgage rates usually follow the trajectory of the yields of 10-year Treasury bonds, unlike credit cards. These yields have been going up and may continue to do so.
"Investors expect the Fed to raise rates, and to some extent that's baked into the market and mortgage rates," said Guy Cecala, chief executive and publisher of Inside Mortgage Finance. "But it's not lock step, and the Fed is a relatively minor factor in determining mortgage rates."
Even so, mortgages will gradually become significantly more expensive in the coming months due to tighter monetary policy and rising bond yields. And the ultimate impact of higher mortgage rates will be much more noticeable to borrowers since outstanding mortgage balances are much bigger than they are for credit cards or home-equity loans.
However, those who have borrowed against properties with a home equity line of credit will be impacted much sooner. Rates on home equity loans are variable, and they will probably go up by a quarter-point after the Fed raises the rates.
Though vehicle loans will also get slightly more expensive, the increase is coming on top of borrowing rates that were relatively low to start with.
"The good news is that there is still intense competition in the auto lending landscape," McBride said. "Even with rates moving up, plenty of people are finding loans for 3 percent a year or lower."
The overall impact on the cost of a vehicle loan will be relatively slight with a quarter-point interest rate increase. Car loans, after all, are not nearly are large as mortgages.
Unfortunately for financially-responsible consumers, returns on savings accounts have never recovered from the interest rate plunge during the 2008 financial crisis and the recession. Although short-term rates have slowly gone up since December 2015, when the Fed began working on normalizing monetary policy, most consumers probably don't know it. Most savings accounts return only 0.1 percent per year at this time.
"If it goes from 0.1 percent to 0.2 percent, who cares?" McBride asked. "If you're waiting at your existing bank for better yields to land in your lap, you're going to be disappointed."
However, a few financial institutions pay much more on savings and money-market accounts, especially credit unions and online banks. For example, the North Carolina State Employees Credit Union currently has a 1.00 percent rate on money market accounts, while online institution Synchrony Bank offers a 1.05 percent rate on its high-yield savings account. Both rates are variable, which means that they will likely go up when the Fed raises rates.
"To see an improvement, you have to have your money at one of the banks that's paying the best yields," McBride said. "You've got to play in the right sandbox."