Beginning in 2015, the Federal Reserve began to raise interest rates more often. In 2018, the central bank has raised interest rates three times and Federal Reserve officials declared that they would another increase in 2019.
The reality is that the Fed had direct control over only one interest rate which is the federal funds rate. However, this the rate that a depository institution, usually a commercial bank, uses to lend overnight funds to another bank. This applies to the funds they maintain at the Federal Reserve bank.
Why Should You Care About a Fed Rate Hike?
Without a doubt, the fed funds rate, as financial experts commonly call it, is perhaps the most influential interest rate in the U.S. economy, if not in the world market. It affects all monetary and financial conditions, directly or indirectly and the effect ripples down on the broad economy. This will sway growth, employment, inflation, and the investment climate. So, when interest rates go up, consumers and business will feel its effects especially on access to credit, purchasing power, and to their financial planning.
Equally important is its pull on the level of nearly all other significant interest rates. We’re talking about bank deposit interests, loan interests on short-term and long-term credit, business and industrial loan rates, consumer loan rates such as credit cards, auto loans, and mortgages. Interestingly, the fed funds rate also stir the value of the U.S. dollar, which in turn affects the value of other global currencies.
Here are 10 things in your life that the fed funds rate will impact:
If you’re planning to buy a home, you’re probably looking at what most American buyers are setting their sights on: a 30-year, fixed-rate mortgage. They have become very popular especially since the financial crisis because the majority of homebuyers find them affordable. The fixed-rate interest dropped down to as little as 3.5 percent. A rate hike will have little effect on them but will seriously influence consumers with an adjustable-rate mortgage (ARM) more than other borrowers.
As a whole, any movement of the Fed’s rate does not affect long-term mortgage rates directly or extensively. But in practice, when the Fed’s rate goes up, banks are quick to pass their higher borrowing costs to their customers.
Lenders usually fix long-term mortgage rates in advance and borrowers know that this rate will not change come hell or high water. What they don’t know is, that the lender has already factored in some provisions for future rate increases. This is why mortgage rates for all types of loans are shooting up these past few months. When the Fed announced that interest rates are likely to go up these coming years, the lenders adjusted their computations accordingly to account for the anticipated rate hikes.
When mortgage rates are climbing, people usually don’t want to buy a house, and for those with fixed-rate mortgages are not likely to refinance. These people know that it will be very difficult to get a better deal.
A rising fed fund usually benefits consumers with interest-bearing bank deposits.
This is because as the rate increases, the interest rates for savings accounts, certificates of deposit and money-market accounts follow suit. However, it is the banks that set how much increase to effect. You can check with your bank to see how much more you’ll be getting on your deposits or placements using the adjusted rates.
When the prime rate increases, it directly pushes the money market and credit-deposit rates. Theoretically, an increase in deposit rates should move consumers and businesses to save more because they can get more interest income. However, it could do the opposite since those with an outstanding credit card, home loan, or other debts would try to pay off their financial obligations to lessen the burden of increased credit rates.
3. Student Loans
In the United States, student loan debt stands at around $1.48 trillion spread out to more than 44 million borrowers. If you’ve borrowed a student loan from federal funds, the good news is, the Fed rate hike will not affect the fixed rate of your loan.
But, if you take out a new fixed-rate federal student loan or the loan that you took charges variable rates, there is a high chance that you will be paying much more. The higher rates may take effect soon because the government resets the rate it charges on new federal loans, fixed-rate and variable, every July.
If you took a private student loan with a variable rate, prepare yourself for an interest rate hike.
In times of accelerating rates, you can avoid paying more by refinancing your loan, so you can lock in on a more affordable fixed rate.
4. Credit Cards
Nearly every credit card has a variable rate, which lenders benchmark to the Fed rate. As the Fed rate goes up, expect the cardholders to experience the crunch.
Any time the Fed raises the benchmark rate, banks immediately follow by pushing their prime rates up and, since they use this to set many consumer rates, they all go up as well – including credit card rates.
So, it’s good to check your bank and see if they are raising their prime rate because they might be charging more for credit card balances. Don’t forget that credit card issuers compound the interest so that magnifies the effect and you tend to pay more in the long run. This means that you begin to pay interest on your actual fund usage plus interest on the interest that you owe.
How can you get out of it? The best solution is to pay off your total credit card balance. If you don’t have the money for that, shop around for a card with a lower rate. Or grab a balance transfer promo offer and insulate yourself from additional rate hikes. But watch out for the fees and terms. Those credit card companies don’t give away things for free – there might be some charges and fees that they’ve hidden somewhere in the fine prints.
5. Stock Prices (businesses profit)
When interest rates climb, stock prices descend partly because the higher cost of loans tends to eat into corporate profits and investors have less money to use for investment.
Higher interest rates might hinder business growth in general and slow growth mean lower profitability, which in turn, cause stock prices to fall. Only banks and other lending institutions directly benefit from interest rates hike by increasing their profitability.
The more the Feds raise their rates, the more likely the banks gain profits. It’s because banks raise their lending rates much faster than their deposit rates, thereby widening the spread between the two and generating more income. They source funds at a very low rate (thru deposits) and lend them out at a much higher rate (thru consumer and commercial loans) – this is a basic banking concept.
6. Home Equity Line of Credit (HELOC)
If you have a mortgage, you can apply for a Home Equity Line Of Credit (HELOC) if you have increased your equity by paying off a substantial portion of your loan or your property has increased in value. You can then draw from the line of credit to get funds to renovate or upgrade your home.
But take note that HELOC rates behave the same way as auto loans: they closely follow the movement of the prime rate, which follows the movement of the federal funds rate. If the Federal Reserve steps up the target rate, then you can be sure that HELOC will follow. This is why you should monitor what the Fed announces with its federal fund’s target rate.
If you have a variable HELOC, you can well end up paying higher monthly payments in the coming months should the Fed funds’ target rate keep going up.
7. Personal Loans
You may have heard that the rates for personal loans are already clambering up in anticipation of the Fed rate’s impending hike. The good thing is that personal loans are short to medium term loans, so there’s ample time for borrowers to do some remedial measures.
Obviously, when banks borrow more expensive money to fund for personal loans, the new rates they will pass on to the borrowers will carry the hike as well.
Existing loans with fixed rates will not experience any changes in the amount of monthly payment for the rest of the term. New loans that lenders approved after the rate increase will surely be more expensive than before.
8. The US Dollar
In theory, when the Fed increases interest rates, global investors take it as a cue to invest in U.S. dollars than other currencies because historically, it gives them a better income.
So, they would often buy dollars and/or dollar-denominated stocks and bonds. The worldwide effect is an increase in the price of dollar-denominated assets and the exchange rate of the dollar currency itself. So, raising the interest rates also raises the dollar’s forex value.
On the opposite end, if the Fed lowers the interest rates so that firms and households can borrow and spend, these same investors tend to suffer. Their return on dollar-denominated assets normally fall, so they let them go in favor of other high-yielding instruments that may be available at that moment. As a result, the dollar exchange rate also falls.
In a nutshell, a Fed funds rate increase influences the value of the dollar in two significant ways:
- First, when Feds raise the rates, it also reduces inflationary pressure, thereby making the dollar stronger and higher in value.
- Simultaneously, higher interest rates prompt foreign investors to focus on dollar-denominated bonds, causing the value of the dollar currency to go up since these investors first need to convert their funds into U.S. dollars before they can buy these assets.
9. Auto Loan Rates
The most unique thing about the Federal funds rate is that it is an overnight interest rate, so it is extremely short-term in nature. That being so, when the Federal Reserve moves to hike interest rates, the decision materially shakes short-term loans such as car loans because they normally carry a term of only 48 to 72 months.
All institutional lenders, whether it is a bank, credit union, or a financing company, will depend on the prime rate to price their auto loans. And, as we’ve mentioned earlier, this rate keeps in step with the movement of the federal funds rate.
You may wonder if the Fed has any impact on wages at all. Well, it does, but a little indirectly as the job market tries to increase employment rates. When the Fed moves the federal rate up, it usually slows down the economy. A slow economy means fewer jobs are available, therefore less and fewer people find work, and it creates more justification for employers to hold back on giving salary increases.
It is a common misconception that the U.S. Federal Reserve dictates all interest rates in the market. The truth is, the Fed only controls one rate, and that is the federal fund rate. This is the rate that depository institutions charge other banks for overnight loans.
However, that rate causes all other rates, both borrowing and lending, to sway accordingly directly or indirectly across the economy – from credit cards to mortgages, all the way to the federal debt. The Fed will strategically raise the fed funds rate to control the pace of economic activity so that inflation does not go insanely wild.