NEW YORK — The Federal Reserve raised its benchmark rate by a quarter point on Wednesday to its highest level in 15 years as part of an ongoing effort to dampen inflation by making borrowing more expensive.
Rising rates will likely make it even more expensive to borrow for homes, cars and other purchases. But if you have money to spare, you’ll probably earn a bit more interest.
The latest rate hike is lower than the Fed’s half-point rate hike in December and its four consecutive three-quarter-point increases earlier last year. The slowdown reflects the fact that inflation, while still high, is easing and parts of the economy appear to be cooling.
But it is still an increase, in a range of 4.5% to 4.75%. And many economists say they still fear a recession remains possible – and with it, job losses that could spell hardship for households already hit by inflation.
Here’s what you need to know:
WHAT CAUSES THE RATE INCREASES?
The short answer: inflation. Over the past year, consumer inflation in the United States has reached 6.5%, a figure that reflects a sixth consecutive monthly slowdown, but which remains uncomfortably high.
The Fed’s goal is to slow consumer spending, thereby reducing demand for homes, cars, and other goods and services, which will eventually cool the economy and lower prices.
Fed Chairman Jerome Powell has acknowledged in the past that an aggressive rate hike would cause “a bit of pain” for households, but said it was necessary to crush high inflation.
WHICH CONSUMERS ARE MOST CONCERNED?
Anyone who borrows money to make a major purchase, such as a house, car or major appliance, will likely suffer the consequences. The new rate will also increase monthly payments and costs for any consumer who is already paying interest on their credit card debt.
“It’s already been a very difficult year for people in credit card debt, and it’s only going to get worse,” said credit analyst Matt Schulz of LendingTree. “The immediacy of the increase is what is difficult – that it not only affects future purchases, but current sales.”
That said, Scott Hoyt, analyst at Moody’s Analytics, noted that household debt payments, as a share of income, remain relatively low, although they have increased recently. So even if borrowing rates rise steadily, many households may not immediately feel much more indebted.
HOW WILL THIS AFFECT CREDIT CARD RATES?
Even before the Fed’s latest decision, credit card lending rates had reached their highest level since 1996, according to Bankrate.com, and these will likely continue to rise.
There are also signs that Americans are increasingly relying on credit cards to keep spending down. Total credit card balances topped $900 billion, the Fed said, a record high, though that amount isn’t adjusted for inflation.
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“Right now, most people may have jobs and rising incomes, but they’re looking to the horizon and seeing storm clouds starting to form,” said Ben Ayers, National Senior Economist. “It’s really an inflection point for the economy.”
As rates rose, zero percent loans marketed as “buy now, pay later” became popular with consumers. But the longer-term loans of more than four installments that these companies offer are subject to the same premium borrowing rates as credit cards.
For those who don’t qualify for low rate credit cards due to poor credit scores, the higher interest rates are already affecting their balance.
John Leer, chief economist at Morning Consult, a polling firm, said his poll suggests more Americans are spending the savings they’ve accumulated during the pandemic and using credit instead. Ultimately, the rise in interest rates could make it more difficult for these households to repay their debts.
For those with home equity lines of credit or other variable-interest debt, rates will rise by roughly the same amount as the Fed hike, usually within one or two billing cycles. That’s because those rates are based in part on the banks’ prime rate, which tracks the Fed’s rate.
HOW ARE SAVERS AFFECTED?
Rising yields on high-yield savings accounts and certificates of deposit (CDs) have put them at levels not seen since 2009, meaning households may want to boost their savings if possible. You can also now earn more on bonds and other fixed income investments.
Although savings accounts, CDs, and money market accounts generally do not follow Fed changes, online banks and others that offer high-yield savings accounts may be exceptions. These institutions generally compete aggressively to attract depositors. (The catch: they sometimes require very high deposits.)
In general, banks tend to take advantage of a higher rate environment to increase their profits by charging higher rates to borrowers, without necessarily offering better rates to savers.
WILL THIS AFFECT THE PROPERTY?
Last week, mortgage buyer Freddie Mac reported that the average rate on the benchmark 30-year mortgage fell to 6.13% from 6.15% the previous week. A year ago, the average rate was much lower: 3.55%. This means that the rate for a typical home loan is still almost twice as expensive as it was a year ago.
Mortgage rates do not always move in tandem with the Fed’s benchmark rate. Instead, they tend to follow the yield of the 10-year Treasury note.
Sales of existing homes have fallen for 11 straight months as borrowing costs have become too much of a hurdle for many Americans who are already paying far more for food, gas and other necessities.
WILL IT BE EASIER TO FIND A HOUSE IF I’M STILL LOOKING TO BUY?
If you are financially able to proceed with a home purchase, you will likely have more options now.
WHAT IF I WANT TO BUY A CAR?
With shortages of computer chips and other parts easing, automakers are producing more vehicles. Many even cut prices or offer limited discounts. But rising loan rates and falling trade-in values for used vehicles wiped out much of the savings on monthly payments.
“With the interest you’re going to pay, these payments might not look too different than they did a few months ago,” said Ivan Drury, chief information officer for Edmunds.com. “It’s like every time we hear good news, it’s outweighed by bad news.”
Since the Fed began raising rates in March, the average loan for new vehicles has risen from 4.5% to 6.9%, according to data from Edmunds. Used vehicle loans are up 2.5 percentage points to 10.6%. Loan terms average around 70 months, or nearly six years, for new and used vehicles.
Edmunds says that since March, monthly payments have increased by an average of $71 to $728 for new vehicles. For used vehicles, it’s only $3 per month at $546.
Financing a new vehicle, with an average price of $48,516 in December, now costs $8,769 in interest, Drury said. That’s enough to drive many out of the car market.
Any increase in Fed rates is generally passed on to auto borrowers, although it is slightly offset by subsidized rates from manufacturers.
HOW DID RATE HIKES INFLUENCE THE CRYPTO?
Cryptocurrencies like bitcoin have lost value since the Fed started raising rates. The same is true for many previously popular tech stocks.
Higher rates mean that safe assets like Treasuries become more attractive to investors as their yields have risen. This makes risky assets like tech stocks and cryptocurrencies less attractive.
Yet bitcoin continues to suffer from issues separate from economic policy. Three major crypto firms have failed, most recently the top-tier FTX exchange, shaking crypto investor confidence.
WHAT ABOUT MY JOB?
Employers across the country continued to hire in December, adding 223,000 healthy jobs. The unemployment rate fell from 3.6% to 3.5%, corresponding to a 53-year low. Meanwhile, job creation was the weakest in two months, suggesting a slowdown, with wage growth also slowing.
“Things are moderating and slowing down, but the job market is still relatively strong,” said Nick Bunker, director of economics research at recruitment site Indeed. “One of the reasons the Fed keeps raising rates is that they think the labor market is too strong.”
Some economists argue that the layoffs could slow rising prices and that a tight labor market is fueling wage growth and higher inflation.
Although layoffs are now at historic lows, it’s also possible that there will simply be fewer vacancies in the coming months.
“I think a lot of hiking is behind us,” Bunker said. “But there is a risk that the job market could deteriorate for some people, so people should be alert to a continued downturn.”
WILL THIS AFFECT STUDENT LOANS?
Borrowers taking out new private student loans should be prepared to pay more as rates rise. The current federal loan range is between about 5% and 7.5%.
That said, payments on federal student loans are suspended without interest until the summer of 2023 as part of an emergency measure put in place at the start of the pandemic. President Joe Biden also announced loan forgiveness, of up to $10,000 for most borrowers and up to $20,000 for Pell Grant recipients – a policy that is now being challenged in court.
IS THERE ANY CHANCE THE RATE HIKES ARE REVERSED?
It looks increasingly unlikely that rates will drop any time soon.
“We expect inflation to still be too high for the Fed even by the end of the year,” Nationwide’s Ayers said. “We expect it won’t be until next year that they start lowering rates.”
By CORA LEWIS Associated Press