The Federal Reserve is widely expected to lift its benchmark lending rate this week for the first time in a decade. It’ll signal that the U.S. economy is healthy enough to withstand higher borrowing costs for consumers and businesses alike.
The Fed’s federal fund rate is a target rate for what banks charge one another for overnight lending. This rate, in turn, influences the cost of loans that are paid back over periods as short as three months and as long as 30 years.
If it happens Wednesday, it will mark the Fed’s first rate increase since 2006. After the so-called “liftoff” on interest rates, which would go into effect immediately, the Fed is expected to continue ratcheting them up, perhaps several times next year and into 2017. Even then, rates are likely to remain lower than the historical average.
Here are three areas to follow if the Fed hikes its closely watched rate Wednesday.
1. Car sales
The Fed’s interest rate has been near zero since December 2008. Since then, the cost of borrowing to purchase a car has been very low and has contributed to a surge in auto sales.
An analysis by credit researchers at Experian shows that during the 12 months that spanned Nov. 1, 2014, through the end of this October, more than 17 million new vehicles were registered in the United States. That’s a number not seen since 2006, a few years before the 2008 financial crisis.
Once the Fed begins raising rates, car buying will get more expensive, as lenders will charge a higher interest rate over the life of the loan. It’s not expected to be a punishingly high difference for many buyers, but for those with lower incomes it might be noticeable.
Even with the lower rates, lenders have been offering poorer borrowers loans over periods as long as seven years. It means lenders earn more interest, because borrowers are paying it over longer periods. Going forward, progressive rate hikes could mean that more lower- and middle-income borrowers take out longer loans, which in some cases might last longer than the life of the car.
2. Home sales
The “liftoff” on rates will also make home purchases more expensive. That may not be immediate, as mortgage-lending rates already have risen in recent months in anticipation of Fed action.
Even if it’s a few months from now, the takeaway is the same: Borrowing costs are going to rise. Take a 30-year loan to buy a $200,000 home. A shift from a 4 percent mortgage-lending rate to a 4.25 percent mortgage amounts to about $58.54 more per month for a borrower.
That’s about $700 more a year, and over the life of a 30-year loan that seemingly small difference amounts to an additional transfer of about $21,000 from the homeowner to the lender.
Realtors expect sales of existing homes to slow in 2016 to 2.9 percent, down from this year’s stronger pace of 7.3 percent through November, in part because of higher borrowing costs.
High-price areas of California and New York are most sensitive to higher rates, but employment – not interest rates – remains the driving factor for national home sales.
On the face of it, the Fed’s action should be good news for savers. The higher interest rates that banks begin collecting from consumers also mean higher returns for people who have savings accounts or certificates of deposit, known as CDs.
The low interest-rate environment has been a boon for buyers of homes and cars but not so great for many older Americans who lived on fixed incomes and have their savings in banks rather than invested in riskier assets such as stocks and bonds.
Initially the rate hike will be of little help to savers, however, since the change will be minimal.