The Federal Reserve is turning to its most powerful weapon to combat the highest inflation in 40 years: raising interest rates. On Wednesday, the central bank said it isits short-term benchmark interest rate by 0.5%, the largest increase since 2000.
The Fed’s goal is to reduce consumer and business demand for goods and services. Raising rates, it is thought, will make it more expensive to borrow money to buy a house, car or other necessities, leading some people to put off purchases. A drop in demand could help control inflation, which has accelerated atthe highest increase since 1981.
The move shouldn’t come as a complete shock to consumers and businesses, given that the Federal Reserve has already boosted rates byin March and signaled more hikes to come. At the same time, Americans have grown accustomed to low interest rates on everything from home purchases to car loans. An increase of half a point, or 0.50%, could translate into higher costs that could affect your budget.
“For the first time in 22 years, the Federal Reserve is poised to raise interest rates by more than a quarter of a percentage point,” Greg McBride, chief financial analyst at Bankrate, said in an email before the Fed’s announcement. “This suggests steps households should take to stabilize their finances: pay down debt, especially costly credit cards and other variable-rate debt, and build emergency savings.”
To be sure, even with the biggest interest rate hike since 2000, when the US was in the midst of the dot-com bubble, rates remain historically low. With the boost, the fed funds rate will likely sit at 1%, compared with 6.5% when the central bank last raised rates by the same amount in 2000, according to data compiled by Bankrate.
This is what the increase will mean for your wallet.
How much will the rate hike cost you?
Each 0.25% increase equals an additional $25 a year in interest on $10,000 in debt. So a 50 basis point increase will translate to an additional $50 in interest for every $10,000 in debt.
However, economists do not expect the Fed to stop raising rates after Wednesday’s announcement. Economists forecast that the Federal Reserve will order another 50 basis point hike in June, with additional hikes later in 2022.
By the end of the year, the fed funds rate could hit 2% or more, according to Jacob Channel, senior economic analyst at LendingTree. That implies a rate increase of about 1.5% from current levels, meaning consumers could pay $150 in additional interest for every $10,000 in debt.
Credit cards, home equity lines of credit
Many consumers will feel the pinch through their credit cards, according to LendingTree credit expert Matt Schulz.
“Your credit card debt is going to get more expensive quickly and it’s not going to stop anytime soon,” Schulz said in an email.
Expect to see higher APRs in a billing cycle or two after the Fed’s announcement, he added. After the Fed’s March hike, credit card interest rates rose by 75% on the 200 cards Schulz reviews each month, he said.
“Most Americans’ financial margin for error is small, and when gas, groceries, and seemingly everything else gets more expensive and interest rates rise, too, it gets that much harder,” he wrote. “Now is the time for those with credit card debt to focus on tearing it down.”
For example, consider a 0% balance transfer credit card or a low-interest personal loan. Consumers can also call their credit card companies and request a lower rate, which is often a successful approach, he added.
Other types of adjustable-rate credit may also see an impact, such as home equity lines of credit and adjustable-rate mortgages, which are based on the prime rate. Auto loans may also rise, although these may be more sensitive to competition for buyers, which could cushion the impact of the Fed’s hike.
Will mortgage rates continue to rise?
Home buyers have already been hit by rising mortgage rates, which have risen about two percentage points in a year, topping 5%.
that’s addto buy a house. For example, a buyer buying a $250,000 home with a 30-year fixed loan at last week’s average rate of 5.3% will pay $3,300 a year more compared to what they would have paid on the same mortgage in April 2021, according to figures from the National Association of Realtors.
But the Fed’s rate hike might not translate into an immediate rise in mortgage rates, LendingTree’s Channel said.
“In fact, this latest rate increase could already be included in mortgage rates that currently sit at an average of 5.10% for a 30-year fixed-rate mortgage,” he said. “That said, rates have risen very dramatically this year, and could go even higher.”
Savings accounts, CDs
If there’s an upside for consumers, it’s that savings accounts and certificates of deposit could offer higher returns.
“Rate increases are likely to accelerate after the Fed’s highly anticipated rate hike in May,” DepositAccounts.com’s Ken Tumin said in an email.
In April, average online bank account yields rose 4 basis points to 0.54% for savings accounts, while 5-year CDs rose 47 basis points to 1.7%.
While that’s a better return for savers, it’s problematic in a period of high inflation. Even with those higher rates, savers are essentially eroding the value of their money by depositing it in a savings account while inflation rises above 8%.