How the upcoming Fed Rate Cut affects your debt
By Sarah Hansen | Published June 13, 2018
The Federal Reserve announced on Wednesday that it will raise the federal funds rate by one quarter-point. So what does that mean for your money?
In short, it means your debt will get a little more expensive. “For borrowers, rising interest rates are like paddling into a progressively stiffer headwind,” says Greg McBride, the chief financial analyst for Bankrate.com.
This will be the seventh hike since December 2015, and rates are already at their highest level since 2008. As part of its mandate, the Fed sets a target for the federal funds rate in order to maintain inflation at its 2% target and maximize employment. Inflation is currently at 2.8% and the unemployment rate is 3.8%. Boosting rates is an indicator of the Fed’s confidence in a strong economy, and it allows policymakers to continue rolling back the stimulus measures that were enacted after the 2008 financial crisis.
Consumers will see the most immediate effects of the rate hike in the form of higher interest rates for variable rate loans like credit cards and home equity lines of credit (HELOC).
“Anything that’s tied to the prime rate will change,” says Chris Geczy, an adjunct professor of finance at the University of Pennsylvania’s Wharton School. The prime rate is the interest rate commercial banks charge their largest, most credit-worthy corporate clients. Banks raise or lower this rate by the same margin that the federal funds rate changes.
As a result, a quarter-point interest rate hike will be passed directly to credit card holders. The average credit card already charges a record-high interest rate of 17%, according to Bankrate.com, and this is likely to increase after the Fed’s announcement. As a result, those who hold variable rate cards can expect to pay a little more in interest each month. McBride says that consumers will likely see a change on their statement within one or two billing statements, or about sixty days.
Cumulatively, the Fed’s rate hike means that credit card users will pay about $1.6 billion in extra finance charges this year, according to a WalletHub report.
Perhaps more importantly, outstanding credit card balances will take more time to pay off at higher interest rates. “Where the real cost comes,” says McBride, “is that it takes longer and longer to pay off that debt.”
Like credit card debt, adjustable rate mortgages are a form of variable rate debt and are susceptible to interest rate hikes, which can manifest for consumers in the form of higher monthly payments. Geczy says that changes to these loans will be slower to unfold because they often compound biannually or on a longer time frame. Long-term fixed-rate mortgages, on the other hand, are not likely to change.
McBride says consumers with adjustable rate mortgages due to reset in the short term should be paying attention to higher rates and may consider refinancing into a fixed rate mortgage.
For consumers with current auto loans or student debt, the impact of the rate hike is likely to be minimal. Because of heavy competition within the industry, auto loan rates have remained fairly low. “I wouldn’t worry about it,” says McBride. “A difference of a quarter of a percentage point is almost undetectable.”
Interest rates on federal student loans are set to rise this summer, but this is because the rates for these loans are based on a May auction of U.S. Treasury notes rather than a direct connection to the prime rate. Consumers with private, variable rate student loans could see their monthly payments rise alongside the new prime rate.
While higher interest rates do make debt more expensive, they aren’t all bad news. Savings accounts, money market accounts, certificates of deposit, and even bonds, while not fixed directly to the prime rate, could see a bump as the federal funds rate climbs higher.
And today’s strong economy may actually make it easier to secure a loan. “All the factors that are leading to why interest rates are rising in the first place are also the factors that make it easier to borrow,” says McBride. With unemployment at an 18-year low, more people are working, earning, and able to pay back their loans, which means banks are more confident that they’ll be repaid and as a result may be more willing to lend.
The bottom line for borrowers? Pay attention to your financing, says Geczy, don’t “set it and forget it.” Consumers should actively monitor the terms of their outstanding debt, especially since these terms may change in the near term. “It just so happens that interest rate changes are in the news,” says Geczy, “and now is as good a time as any to pay attention to it.”
Source: Forbes
