The Federal Reserve raised its benchmark interest rate Wednesday for just the second time since the 2008 financial crisis.
Economists talk a lot about the impact this will have on markets, but what about everyday consumers?
The Fed’s decision can affect the cost of housing, cars, student loans and even the interest on your credit card – though not all necessarily right away. And when the Fed raises rates, all sorts of other expenses eventually tick up.
The move is part of what will be a slow, upward climb for what’s known as the federal funds rate. Banks are ordered by law to have a certain amount of money in reserve, so they typically make overnight loans to each other to keep those balances up. The federal funds rate is the level of interest that applies to those short-term loans.
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Because the rate has been close to zero since 2008, as part of the Fed’s strategy to bring the nation out of a recession, there’s hardly anywhere for it to go but up. As the economy improves and President-elect Donald Trump unveils his stimulus package, economists expect rates to rise steadily over a period of years.
“The bottom line, ostensibly, is that the economy is getting stronger,” said Dean Baker, co-director of the Center for Economic and Policy Research. “Nobody in their right mind would say, ‘I’d rather have higher unemployment and lower interest rates.’ Nobody wants to pay a higher interest rate, but I think that’s an easy choice for most people.”
If you’re going to buy a home, chances are that you will opt for a 30-year, fixed-rate mortgage. Most home buyers do. Those loans have become remarkably affordable, especially since the financial crisis, with their interest rates bottoming out at around 3.5 percent.
In general, movement of the Fed’s rate does not have a large, direct impact on long-term mortgage rates. But when the Fed’s rate goes up, banks find ways to pass their higher borrowing costs along to consumers.
And because long-term mortgage rates are set in stone, they also factor in the anticipation of future rate increases. That’s part of why mortgage rates have been shooting up in recent months: The Fed has suggested that interest rates are likely to continue rising for years.
The average interest rate on a mortgage this month is 4.3 percent, according to LendingTree, and the average loan on a 30-year, fixed-rate mortgage is worth about $237,000. If the borrowing rate were to rise by, say, another percentage point in the coming year, this would mean an additional $138 a month on the average mortgage – leading to nearly $50,000 in added interest over the duration of the loan.
As mortgage rates go up, people are a little less likely to buy a house, and those with fixed-rate mortgages are less likely to refinance (because they probably will not end up with a better deal).
An interesting wrinkle is that as a result, volume – that is, the amount of new mortgage contracts being issued – goes down. So brokers could also start loosening their requirements for new mortgages.
Credit card rates
The annual percentage rate on your credit card can be anywhere from 15 to 20 percent – much higher than the interest rate on a mortgage or a car loan.
An uptick in the Fed’s interest rate might cause your credit card’s APR, if it’s variable as opposed to fixed at a specific rate, to bounce by 1 or 2 percentage points. The effects of that can be larger than they may initially seem, in part because the interest compounds. That is, you begin to pay interest on what you owe and the interest that you have been accumulating on that.
“If you’re accumulating credit card debt for a year,” said Markus K. Brunnermeier, a Princeton economist, “moving from 13 percent interest to 15 percent is a much bigger deal than moving something from 1 percent to 3 percent.”
Rates for student loans, like other forms of borrowing, are at a relative low. But as the Fed’s rate rises, that will change for those just starting to think about paying for college.
Federal loans are tied to the 10-year Treasury rate, which factors in the Fed’s anticipated interest rates over the coming decade. Because these rates are projected to tick up steadily by the Fed’s own forecasts, students planning to take out loans in the next few years can expect the government’s student loan rates to rise.
“Students taking out new debt will be looking at higher payments,” Baker said, adding that he expected rates could rise by 1 or 2 percentage points in the next few years.
Rates for car loans, too, are already climbing in response to the Fed’s expected move. Auto loans tend to last only a few years, so there is still time for car buyers to get ahead of the curve.
That’s because the Fed, in its most recent economic projection, predicted that interest rates will continue climbing into the next decade. A few years from now, a car loan issued in 2017 could be fully paid off, and interest rates may still be on the rise.
“If you’re thinking of buying it now or in two years’ time, you should buy it now,” Brunnermeier said.
What about renters? An interest-rate increase may also affect them – just not as directly.
Higher rates mean that landlords must pay more to purchase and renovate their properties, so in the long run, those are costs they could easily pass on to renters – though it’s not necessarily a given that it will happen.
And with the labor market improving, workers’ wages could rise at about the same time as rent prices, said Stephen D. Oliner, a resident scholar at the American Enterprise Institute and former member of the Federal Reserve Board.
“It’s possible that with their wages rising, people will be able to keep up with the higher payments on their rents,” he said.